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Loan Modification

Facing foreclosure can be overwhelming and scary, but by taking the right steps you may be able to keep your home and save your credit. The following information is provided to help give you a better understanding of loan modifications.

Overview of Loan Modifications

A loan modification is one of the best options available for struggling homeowners and lenders alike.

A loan modification is beneficial to the borrower because it allows the individual or family to remain in their home and grants them loan terms that work better for their particular life style or situation. A loan modification in comparison to foreclosure, bankruptcy, or some of the other options, allows the borrower to keep their credit score intact.

Loan modifications are also beneficial to banks and lenders, especially with foreclosure rates sky rocketing in the last few years. Banks lose a lot of money in a foreclosure. Not only does it cost money to go through with a foreclosure but it often results in an overall loss for the banks, as the homes often sell for less than they are worth, or less than the outstanding loan amount itself.

In a CNN report on March 6, 2008 Bob Moulton of America Mortgage said, “It’s cheaper for a bank to renegotiate payments than to chase someone and miss out on monthly mortgage payments.” This is entirely true; banks lose over 50 cents to the dollar on homes that are sold through foreclosure auctions.

Loan modification is a long-term solution that will help the borrower make their loan payments and stay in their home. This can be accomplished by:

  • decreasing the interest rate
  • changing from a variable to a fixed rate mortgage
  • extending the term of the loan (the period of time the borrower has to pay the loan back)
  • switching to a different type of loan altogether

Some forms of loan modifications are more easily obtained than others. One of the easiest ways to modify your loan is to ask for a decrease in the interest rate. Most lenders are willing to aggressively decrease interest rates for qualified applicants. A decreased interest rate can save you anywhere from a few hundred to a thousand dollars every month; this depends on the amount of your loan.

Lengthening your loan is another way to modify, which is often not too difficult to have a lender carry out. By increasing the number of years you have to pay off a loan a homeowner can decrease their monthly payment by a couple hundred dollars. However, it should be noted that this option increases the overall amount of the repayment as extra interest accrues over the extended period of the loan.

A principle balance reduction is the most difficult loan modification to obtain. This involves the lender forgiving a portion of your debt. It is very difficult to get a lender to agree to this type of modification, because the lender has to report that money as a loss on its balanace sheet and the purpose of the loan mod is to minimize losses.

Background on Loan Mods

Sub-prime mortgage practices deserve much of the blame for the current crisis. Throughout the early part of this decade, mortgage lenders earned huge profits lending money to borrowers with questionable credit histories. The roaring housing market and the availability of easy credit perpetuated a cycle of refinancing whereby a borrower that could no longer afford their monthly mortgage payment could simply refinance into a new mortgage; often at a low teaser rate.

Once the housing market stalled, however, sub-prime borrowers found themselves unable to refinance. This led to record numbers of foreclosures. As reported in a New York Times article in December 2006, "about 1.1 million homeowners who took out sub-prime loans in the last two years will lose their houses in the next few years." The article further explains that, "foreclosure will cost those homeowners an estimated $74.6 billion, primarily in equity."

Recently, a new wave of problems has arisen from so-called Alternative-A loans. These Alt-A loans were very popular over the past several years among self-employed borrowers or those with stated incomes. Many individuals who obtained Alt-A loans have been unable to stay current on their mortgage payments, especially as those loans have adjusted to higher interest rates. With housing prices dropping, borrowers are finding themselves upside-down and actually owing more on their loan than the value of their home.