Mortgage modification would indeed provide a windfall for some troubled homeowners — but its costs will be borne by aspiring future homeowners, and by any American who uses credit of any kind, from car loans to credit cards. The ripple effects could further roil America’s consumer credit markets.

In the first place, mortgage costs will rise. If bankruptcy judges can rewrite mortgage loans after they are made, it will increase the risk of mortgage lending at the time they are made. Increased risk increases the overall cost of lending, which in turn will require future borrowers to pay higher interest rates and upfront costs, such as higher down payments and points. This is illustrated by a recent example: In 2005, Congress eliminated the power of bankruptcy judges to modify auto loans. A recent staff report by the Federal Reserve Bank of New York estimated a 265 basis-point reduction on average in auto loan terms as a result of the reform.

Congress is considering legislation that would allow bankruptcy judges the ability to change mortgage terms such as interest rates and and amount owed.

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I challenged her on the tax deductibility part since the provision only allows tax deductibility for 2007 and for individuals with less than $100,000 annual income. While the income part may cover most people, the fact that it is only available for loans taken in 2007 is cause for worry. However, the presenter strongly felt that this would be renewed for 2008 and beyond.

The second point made by the presenter had to do with the subprime crash and the subsequent effect it has had on seconds liens. For borrowers in the lower credit score range second liens have become very expensive. We are talking about a one to two percentage points increase in the rate. This can make the second mortgage substantially more expensive. MI can certainly look very attractive in this situation.

There are two methods of using MI in todays market. The first is borrower paid monthly MI. This is a monthly amount paid into an escrow account with monthly taxes and insurance. After the close, the borrower has the option to call the loan servicer to cancel this payment if the borrower has either paid down the principle quickly or, the loan to value has fallen to 80% of the house value by sheer home appreciation. A new appraisal is usually required, paid for by the borrower of course, and many servicer will not address the issue until at least two years after the transaction has closed. Different loan service companies have different rules on this so, check with your particular loan servicer for exact requirements.

The second method is the Lender Paid MI (LPMI) where the lender increases the rate by a certain percentage to cover the MI. The main argument against the LPMI is that the loan payment can never be reduced. However you have to remember that in a high loan to value situation it will be a long time before you reach less than 80% LTV anyways. So, if you are planning on being in the house for only a few years this can make good sense.

After the presentation I had a discussion with a Senior Loan Office at CTX Mortgage. (He has been a mentor figure in my career.) He has determined that Lender Paid MI (LPMI) is usually the better solution where the LTV is high and the borrower has a lower credit score. In the situation of lower LTV and higher credit score then monthly borrower paid MI may make sense but you have to make sure you find a competitive MI provider.

Every situation is different and there are many MI companies out there. To determine what is best for you, I suggest working with a good mortgage professional who understands the nuances of the different MI scenarios.

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“As a lender we can set it up so that you pay your taxes every month (total taxes due per year divided into 12 equal payments). We hold that money and then when it is due we forward it to the government. This is the type of loan we have you set up for.

However, if you choose to pay your own taxes then you can certainly do that. However, the lender views this as an added layer of risk and sometimes will bump up the interest rate a bit to cover this risk. The risk being that if you’re not good with setting aside money every month for the semi-annual tax payment you’ll be late on your taxes or you stop making mortgage payments to pay taxes. Not paying your taxes over a period of time means the government then can attach a tax lien to the house. We are lending with the assumption that we’re the first lien holder but the government has power to get ahead of us. Hence if we have to sell the house to recover the loan then the government gets it taxes first before we can get our money to cover the loan.

I always recommend that clients set up an impound account with the lender and pay taxes on a monthly basis as part of the mortgage payment.

The same idea applies to your monthly homeowners insurance payment.”

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