Here at the Mortgage Calculator, we try to provide timely updates on the government’s loan modification program. It has many shortcomings, which are responsible for the program’s dismal 9% participation rate. Since then, we’re happy to report that the program has really taken off, as the largest lenders have been shamed by the federal government into submission.

According to Bloomberg News, “Bank of America Corp. and Wells Fargo & Co., among the worst performers of banks in the U.S. government’s main foreclosure prevention plan, stepped up their pace of mortgage modifications by at least 60 percent in August.” Leading the pack is Morgan Stanley’s mortgage origination unit, which has modified over 40% of eligible loans, defined as owner-occupied homes, with a pre-2009 conforming mortgage that is in danger of “imminent default.”

As always, the devil is in the details, since a loan modification doesn’t necessarily lower the risk of default, and doesn’t even translate into a lower payment. “Of loans modified from Jan. 1, 2008, through March 31, 2009, monthly payments increased on 27% and were left unchanged on an additional 27.5%…Many modified mortgages fall delinquent — 25% to 40%, depending on the type of mortgage — often because of homeowners’ loss of income or additional outstanding debt…”

There are a few reasons for these outcomes. First of all, when executing loan modifications, lenders can choose between lowering one’s interest rate (temporarily or permanently), extending the loan term, and cutting principal from the loan amount. In theory, all would seem to lead to lower payments, but as the statistic above attests to, this is the case less than half the time, due primarily to the adding back of deferred taxes. Astonishingly, over 90% of loan modifications lead to higher principal balances.

Advocates argue that this represents the best approach. They point out that mortgage problems for many are a temporary result of unemployment, rather than long-term financial hardship. “A lot of what’s being done is a misplaced focus on modest, long-term relief when what they need is fast, short-term, massive relief (due to job loss),” maintains one economist. This philosophy is reflected in Bank of America’s approach to loan modification, which offers “mortgage forgiveness for three to six months in hopes the borrower will find a new job in that time.”

Those on the other side of the debate argue that this misses the point, and that the focus instead should be on “permanent debt reduction.” Many have begun to direct their attacks on the industry’s Net Present Value model, which is used to asses whether a loan modification is ultimately in the best interest of the lender. According to critics, this model is overly conservative, and leads to an overly high rate of rejection. At the very least, it confirms what cynics have maintained all along- that the mortgage lending industry still does not remain behind the loan modification program.

There’s even a small minority of critics who insist that loan modifications are a bad deal, on the grounds that it damages the credit of borrowers. “Under reporting guidelines set forth by the credit bureaus and the Consumer Data Industry Association, your loan modification will be reported as a ‘Partial Payment Plan.’ Under the FICO scoring method, that designation will lower your credit scores, even if you have never missed a payment.” From a credit standpoint, then, loan modification is not much different from foreclosure that far away from foreclosure, and might ask some to consider whether the consequences justify it.

Outside of this debate are the millions of people still waiting to receive modifications. For every borrower that is emerged “victorious” from the maze of requirements, there are at least 10 more who are stuck in “loan modification hell,” as one columnist put it. Anecdotal reports indicate that the experience is both time-consuming and frustrating; the best advice is to be patient, and to keep a paper-trail.

When filing a mortgage application, you will be required by your lender(s) to submit certain documentation, in order to prove both your income and your assets. While your lender will most likely inform you of specific requirements, you can save yourself precious time by preparing all of the documents in advance.

In terms of proof of assets, you should begin by compiling information on all of your bank accounts, including account numbers, the branch address(es), and copies of recent statements. Remember to include information for both checking and savings accounts. You should also plan on furnishing statements of other liquid assets, such as IRA retirement accounts, CD’s, annuities, and estimated cash value of life insurance policies. It wouldn’t hurt to provide valuations for Illiquid assets (real estate, valuables).

The next step is to document your income. This is best achieved through the provision of pay stubs, W-2 withholding forms, and even recent tax returns. If you are self-employed, you should prepare audited income statements for your business. Generally, lenders won’t require more than two years worth of data, but in some cases, they may request additional information.

Even if your creditworthiness has been established (and especially if it isn’t), it wouldn’t hurt to show timely payment of rent and utilities for the last 1-2 years. Your lender will also need to see and legal documents/filings (related to divorce, etc.) in order to determine if any potential liabilities exist.

Prior to the bursting of the housing bubble, it was possible to obtain a competitively-priced loan without providing any or all of the documentation listed above. Reacting to lending standards that were perhaps overly stringent, lenders gradually loosened their requirements. This led to lender complacency and the consequent proliferation of so-called liar-loans, which describe mortgages that require little or no documentation.

In some cases, it is still possible to obtain such loans. Some lenders will accept stated income and/or assets (as opposed to verified income and assets), but you can expect the spread to full documentation loans to be higher than before. According to a recent report, “Less-documented borrowers who reported high incomes were far likelier to default than those whose high incomes were verified – suggestion that loans were made on misleading information.” The report found that applicants were likely to overstate income by 20% on average when verification wasn’t required.

For some applicants, namely those who are self-employed or in-between jobs, a low-documentation loan might still be the best choice. No-ratio loans, whereby income and assets are verified but not used to calculate typical do-not-exceed ratios, might be necessary for those who want to purchase houses that are technically unaffordable.

Of course, you should speak to a loan officer before deciding whether a low-documentation loan is appropriate for you, but it helps to know your options before going in.