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Loan Modification Process: Details of the Waterfall Method and How It Applies to Your Loan

The loan modification process involves a standard loan modification method on new affordable monthly payment terms. This is called the waterfall method and is required for use under the Treasury Department’s loan restructuring plan. This plan is called HAMP – for Home Affordable Modification Program. When your lender reviews your application, part of the process will be determining if your loan and financial circumstances will fit into this modification method.

The loan modification process begins when a borrower contacts their lender and requests consideration for HAMP. It is important to specifically apply for this plan because lenders must review each and every homeowner who applies for help under this plan. While your file is being reviewed to verify your eligibility, the lender cannot move your home up for foreclosure sale. So this gives you some time and a second chance to save your home with a loan restructuring.

Once you complete your loan modification application and submit it along with your income documentation, your entire package will be reviewed for eligibility and acceptability. This is the basic loan modification process:

1. Homeowners request consideration for HAMP
2. Borrower completes application package and provides proof of income
3. The lender reviews the information provided by the homeowner for eligibility
4. Cascade modification method is attempted and acceptability is determined
5. If the loan can be modified using the standard terms, then the homeowner may be approved for a loan modification.
6. The owner enters the 3-month trial modification period, after which the modification becomes permanent

How exactly does the cascade modification method work? This standard formula uses various criteria to determine which loans and borrowers will be eligible. Remember that the owner is providing their financial information: monthly income, monthly expenses, cash in the bank, etc. – on your application form and this is the information that is used to determine if the owner will qualify. The lender will use standard methods to reduce the current mortgage in order to meet a new target mortgage payment. This new payment will equal 31% of the monthly gross income reported by borrowers and includes principal, interest, taxes, insurance and any HOA due.

The first step of the waterfall method to reach the target payment is to reduce the interest rate, and the rate can go as low as 2%. If more changes are needed to reach the goal, then the term of the loan can be extended to 40 years. The final step is to forgive or defer any principal balance to reach the desired new target payment. This is called the Waterfall Method because the lender must follow these steps in order, as needed. However, if the borrowers’ income is too low or too high, or if the loan balance is so high that a large principal reduction would be necessary, the loan modification may be denied.

Homeowners waiting to be approved must understand how the loan modification process works and, more importantly, how they must complete their financial statement in order for it to be acceptable. If you know in advance how much income you need to prove to qualify, then you will be able to make the necessary adjustments and submit an acceptable application. If you knew that simply cutting a couple of hundred dollars a month in spending would fit the guidelines, then you certainly would, right? This is confusing to borrowers, but you can use a loan modification software program that will actually show you how much income you need and where you may need to adjust your figures to fit HAMP’s standard guidelines.