How to Owe More on Your Mortgage? Get a Loan Mod

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Wait, aren't loan modifications supposed to provide financial relief? Yes – if you consider a teaser mortgage rate to be a bargain.

A new report finds that seven in every ten borrowers who have received a change in their mortgage in order to forestall foreclosure actually now owe more in principal than they did when they started.

Yes, more.

Those borrowers gain in the short term, by lowering their monthly bills. But in the long run they're in more debt than when they started.

The State Foreclosure Prevention Working Group, a consortium of attorneys general from 12 state and banking regulators from three, has been collecting data from mortgage servicers, the bill collectors who receive mortgage payments from borrowers and pass them on to investors in mortgage-backed securities. Over the last two years, the group has been investigating how borrowers fare when they run into trouble on their mortgages, and what kinds of modifications and workouts they're getting from their servicers.

What they've found isn't pretty. Servicers are so extremely backlogged with modification requests that, at some, the average time to complete a modification is more than six months. Only four in every ten borrowers in serious trouble is even talking to a servicer about repairing their loans. And in many cases that's smart of them, because what the loan modifications effectively do is force homeowners to commit to owing even more than they did than when they started, on a property that is likely worth much less now.

Anyone who has been paying attention to shouldn't be surprised that most borrowers who get loan mods now owe more than when they started. After all, they're not getting reductions in the principal they owe, just a temporary drop in their interest rate. Sooner or later, they have to pay back most or all of what they owed, and that bill is tacked on to the end of their mortgages. According to the new report, only 9 percent of borrowers receive a significant reduction in principal owed. The vast majority, 72 percent, see loan balances grow, as unpaid interest and various fees get piled onto the principal.

This is why the hand-wringing about how some lenders, like Bank of America, aren't doing enough to get borrowers loan modifications is somewhat misplaced. For a borrower who owes $400,000 on a house now worth $300,000, it's most likely a bad idea to sign up to owe even more principal – even worse if he or she is now unemployed. No matter how aggressive servicers get about signing borrowers up, many are going to look at the math and say, no thanks.

But what's really frustrating here is that none of this is a surprise – increasing loan balances is intrinsic to the workings of the Home Affordable Modification Program. Even the sample loan mods the Obama administration presented when it announced HAMP nearly a year ago showed principal balances rising.

The only way out is to reduce the loan balances borrowers owe, instead of ballooning them. As the Treasury department figures out how to fix its loan modification program, it will have to find a way to do that. With foreclosures projected to be higher this year than last, mortgage-backed securities investors have no choice but to cooperate.
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