Few Mortgage Modifications Include Principal Reductions

Mortgage modificationHave the mortgage-modification floodgates opened? For the one-in-four American homeowners who owe more on their mortgages than their homes are worth, a reduction in the mortgage's principal balance can shift the borrowers' math and their mindsets in favor of staying in the game: Drop the amount of their loan and they make more of an effort to keep making payments and avoid foreclosure.

The data bears this out; the industry-wide re-default rate on loan modifications overall hovers around 53% six months into the modification, but only half as many homeowners re-default after a loan modification that reduced the principal owed on the loan.Yet no amount of pleading by borrowers, data-backed logic -- not even the Obama Administration's flat out offers to pay mortgage banks to ramp up their principal reducing loan mods -- have been effective. The most recent data available shows that only 4% of loan modifications include a principal reduction.

Mortgage servicers and investors have long held out against reducing principal balances on, well, the principle. Their concern is that reducing principal balances for some homeowners will cause a mad stampede in which every homeowner in America would refuse to make payments until the bank brought their loan balance down. Last year JP Morgan Chase's chief home lending executive told the House Financial Services committee: "We are concerned about large-scale, broad-based principal reduction programs." Wells Fargo Mortgage Co-President Mike Heid agreed, telling the committee at the same hearing that "[p]rincipal forgiveness is not an across-the-board solution."

Lately, though, America's largest mortgage servicers appear to have started to relent. Perhaps persuaded by continued declines in home values, still-slow sales activity and an uptick in strategic defaults (which have been statistically shown to beget more strategic defaults, as friends and family members of former homeowners view their walkways as inspiration), lenders are finally starting to hop on the principal reduction bandwagon.

Bank of America -- one of the toughest banks from which to get a loan mod of any sort -- is launching pilot programs to reduce principal mortgage balances on upside down homes in Arizona, Nevada and California, and has actually begun sending letters out to as many as 8,000 Arizona borrowers who may qualify for the program. Wells Fargo and Ally Financial, formerly GMAC Mortgage, have just signed on to their own principal reduction programs, though Wells reduced an average of $51,000 off the balances of around 73,000 borrowers in 2009 and 2010, according to SmartMoney. JP Morgan Chase says it is planning to open 30 brick-and-mortgage, scratch that, brick-and-mortar "help centers" this year dedicated to finding solutions for homeowners in distress. Many of these principal reduction programs are being offered under the auspices of the Hardest Hit Funds, in which the U.S. Treasury Department, the state and mortgage investors will all chip in funds to bring down mortgage balances of borrowers in foreclosure hot-spot states, listed here.

But before you begin fluffing up your recession-depleted net worth statement, be aware that you will have to show much more than being upside down before your bank waives thousands off your loan balance. And all of them require homeowners to document their finances in detail, including any temporary hardships and documentation that you have enough income to pay your modified payment. Plus, you don't necessarily get to choose which loan modification solution you get from your bank; while it makes sense to ask for a principal reduction in your loan mod hardship letter, chances are good that you'll be offered a reduced interest rate or payment, reinstatement (where a loan in default is brought current -- with or without all the back payments being made) or deferred loan balance (where payments are waived on a portion of the mortgage debt for a period of time) over a principal reducing loan mod. But it certainly doesn't hurt to try!
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