However, if the new financial services law passes (and it may not thanks to continued Republican blocking), you will be able to get a free credit score when, and if, anyone turns you down for credit.  They have to tell you what score they used in their evaluation and what it was.

Let’s say your mortgage is $1,000 a month, but you can afford only $800 a month.  By not paying your mortgage you could use that $800 to pay down your credit card debt.  $800 may not seem like much, but the average length of time it takes for the lenders to execute a foreclosure is up to more than 14 months.  14 times $800 is $11,200!

You should not do this unless you are willing to lose your house, or know that you have no choice.  If you think you can get your lender to lower your payment to 31% of you income, and you are willing to pay that amount, you have a choice.  You could do a mortgage modification.  (For more information, click here to our blog entry on qualification for mortgage modification.)

If you do choose the foreclosure option, be sure to save some of the money for rent (first, last and security).  You will need it when you move out.   And something should be set aside for possible legal fees.  (For example, post-foreclosure bankruptcy may be necessary in some situations to get rid of the part of your mortgage not covered by the sale of your house.)

Well times just changed.  As of June 1, bankruptcy judges can force lenders to follow the guidelines of the administration’s HAMP program.  This applies only to people who file Chapter 13 bankruptcy, which means that you will pay some portion of your debts, as modified by a judge.  Up until now, however, judges could not do anything about modifying residential mortgages.

This will work as follows:  When you file bankruptcy you list all of your income and your debts.  The mortgage debt, based on the HAMP program, will be reduced to 31% of your income.  So if you make $40,000 a year, your monthly mortgage payment will be slightly over $1,000 a month.

The judge will then add up the rest of your debts, modifying interest and principle as necessary, to create a payment you can cope with.

This will not work in all cases, but it is a lot better than getting stiffed again and again by your mortgage lender.

The program is designed to lower mortgage payments to 31% of income, and that is often achieved.  The typical (median) family applying to the program has a payment that hits almost 45% of their income, according to the Wall Street Journal, and gets that reduced to 31%.

Unfortunately, this may not be enough because many people also have other debt, including credit card debt.  If you take total debt, the typical mortgage modification applicant pays an astounding 77.5% of their pre-tax income to cover their debts.  Even after the loan is modified, their debts chew up 61% of income.   That is simply too much.  Your total debt payments shouldn’t exceed 50% of income, and even that is high.

The solution to this problem is to get your other creditors to reduce their demands.  In the case of unsecured debt, like credit card debt, bankruptcy courts can dictate a reduction or elimination of unsecured debt.   You may not need to go to court.  You can often work with the creditors to get debts lowered.

Elsewhere on this site, I recommend Consumer Credit Counseling Services.   The WSJ has an example of what agencies like CCCS can do (in the case they cite it was Springboard, Inc in Riverside CA).

The Journal reports on a couple who started out with debt payments that took 71% of their income.  The agency negotiated a mortgage modification and lower interest rates on their credit cards.  It convinced them to give up one car (eliminating that loan payment) and got them food stamps.  Their debt load is now 41%.

These debt settlement firms are the ones you usually see advertising on TV.  They make all sorts of claims in offering debt solutions.  Some claim to be government programs, one says you can stop paying your creditors forever, and all claim that they can help you reduce your debt without filing bankruptcy.  I have long said these claims were not to be trusted.  Now the FTC has confirmed it.

If any company or organization asks for an upfront fee (usually thousands of dollars) to offer you debt help without filing bankruptcy, run the other way as fast as you can.  Only a very small percentage of people actually get any help at all.

The best alternative to bankruptcy is a debt management plan, which works like this:

All of your creditors are contacted and told that you are going into a debt management plan.  They will start getting paid once a month, IF they stop piling up interest and late fees.  Often previous interest and late charges are eliminated, and a lump sum total is fixed.

You send one monthly check to the debt management organization. They take out a small processing fee and send the rest to your various creditors, usually collecting a small commission (8% is typical).  This goes on until the agreed upon amount of debt is paid off.

The only organization I trust to conduct debt management plans effectively is one I have had experience with, Consumer Credit Counseling Services.  You can find local branches and more information at LINK www.nfcc.org.

Here are the names of the six worst debt settlement offenders according to the FTC:

Freedom Fidelity Management, Procorp Debt Solutions, Web Credit Advisors, A New Beginning Financial and Ministries, Credit Solutions of America and FreedomDebt.com

Congressman Barney Frank, Chair of the House Financial Services Committee has argued quite persuasively that the only way we are going to end the problem of unaffordable mortgages is to “cram down” the principle.  He wrote to four big banks, arguing that “to save homes on a large scale we must move past temporary modifications in interest rates or terms and focus on permanent principle reductions that result in truly sustainable mortgages.”

The Obama administration’s most recent patch to their unsatisfactory “making homes affordable” program recognized the wisdom of this and added inducements for lenders to reduce principle when interest rate reductions won’t work.

I have long argued that it is usually better for the homeowner, the neighborhood and the banks to cut principle than it is to foreclose.  When everything is totaled, it almost always costs a lender far more to foreclose than it does to cram down the principle.

You would think that with all this logic and support, cram downs would be common.  But, no, the banks are pushing back.  They do not want to reduce principle now because under current accounting rules, foreclosures postpone the loss, and the longer they postpone their loss the better their current bottom line looks.

The only way out of this is, as I have argued before, to let bankruptcy courts do the cram down.  Right now they can reduce the principle on your vacation home, your investment property — even your yacht — but not on your home.  Just knowing that the court can do this would make the banks more amenable to principle reductions.

No one files bankruptcy lightly.  And bankruptcy courts are very careful with all debt forgiveness.  They do not make plans that hurt the lender more than necessary and they do not approve plans that cannot work.  I talked to a bankruptcy lawyer about this and he said that he is always very careful to submit a plan for approval that can work, and is fair to the creditors, because if he does not do that then the court will throw it out, and start going over all his plans with a fine tooth comb.

A bill to allow bankruptcy judges to do these cram downs was defeated in Congress after heavy lobbying by the banks.  Now they are fighting even voluntary principle reductions.

Short sales can be a win-win-win.  They are less harmful to the seller’s credit score than foreclosure, and banks end up losing less on a short sale than they would on a foreclosure.   (One study says banks lose twice as much when they foreclose as they do with a short sale).  Not only that, but the house does not lie vacant, which attracts vandals and lowers all values in the neighborhood.

The problem with short sales has been that banks have made it very difficult to do.   You would have to find a buyer who makes an offer and then wait, sometimes months, for the bank to tell you whether or not they would be willing to accept the offer.

Under the new rules, banks are encouraged (and sometimes required) to agree to a price in advance, using normal appraisal methods, and to accept any offer that netted them 88% or more of that offer.

This should make these sales a lot quicker and easier.  And once you make a short sale under this program, the government will give you $3,000 for moving expenses. In addition if you buy a new home after selling you could qualify for a 1% subsidy if you get a loan insured by Fannie Mae or Freddi Mac.

The banks will still be leery of short sales, thinking homeowners are playing tricks on them.  You will not qualify if the cost of your mortgage does not exceed 31% of your income, or could be made to come to that number with an interest rate reduction.  For more details on the 31% issue, see our post on Qualifying for Mortgage Modification.

That number is 31% — roughly one-third.

The fact is that the various mortgage modification and foreclosure prevention programs assume you can pay 31% of your income toward your mortgage.  That is almost one-third of your income.  Not a small number.

If your mortgage payments are not more than 31% of your gross income, they do not think you need relief.  And if you do qualify for relief they will adjust your mortgage payments until they are lowered to 31% of your income.  Usually they will not go lower.

Let’s say your income is $50,000.  Your mortgage payment would have to be more than $15,500 a year, or almost $1,300 a month for you to qualify for mortgage modification.

Let’s suppose your income is $50,000 and your mortgage is $20,000 (or about to go to $20,000 after variable rate adjustment).  You would qualify on this basic provision, and if you qualified in other areas AND all went well, the lender would use some combination of interest rate reduction (not below 2%) and principle forgiveness to get your payment down to less than $1,300 a month.

This is what you can hope for.  If you know that up front, you need to decide if that is OK with you.  You may think that you cannot pay 31% of your income for your mortgage, and if so, there is probably little reason for you to start down the road to mortgage modification.

The financial community has fought that idea tooth and nail, and they have stopped all attempts to change the bankruptcy law.  But the concept of “cram down” is getting a new life, thanks to Bank America (which started its own program this week) and the administration’s Home Affordable Mortgage Program (HAMP), for which a series of revisions have been announced.

While there is a brief summary of important provisions below, the program details and paperwork will make you nuts (what else is new?); and I recommend that  you get in touch with a free, federally sponsored counselor to help you.  A list of local counselors is available from HUD.  You can also get names of approved  counseling organizations from the Hope website or by calling the HOPE HOTLINE at 888-995-4673.  You can also call 1-877-894-HOME (1-877-894-4663).  The Neighborhood Assistance Corporation does this work too.

The new government program, which will take some time before it becomes fully effective, has many new provisions

1. If you are unemployed, you should be able to get a three- to six-month forbearance on your mortgage payments, after which you can apply for a permanent loan modification if appropriate.
2. If your mortgage payments exceed 31% of your income on your residence, and reducing the interest rate does not get you down to 31%, then the lender is required to consider lowering the principle enough to bring the payments down to 31% of your income.  (Consideration is mandatory.  Action is optional, but there are incentives for the lender to go ahead.)  Your loan must be at least 115% of the current value of your house.
3. Second mortgages (such as home equity loans) have been a real thorn in the side of anyone trying to do loan modifications.  This new plan increases incentives for second mortgage holders to settle and get out of the way.
4. If there is no way to get the loan payments down to 31% of your income, the new rules will make it easier for you to turn over your deed and get out of your house without going through foreclosure, and without owing any balance.
5. The new rules also provide help for homeowners who have been paying their bills but whose houses are “under water” but who don’t want to move.  Once again, the government will provide incentives for lenders to reduce principle to get loan down to 115% of current house value and reduce payments to 31% of income.

Full (endless) details are available at www.makinghomeaffordable.gov.  When I went there today there were lots of broken links but I found what I wanted in a cached copy.