Increasingly Loan Modifications Being Criticized

A new report from bank regulators shows that banks are beginning to lower the principal balances due on home mortgages for some struggling borrowers, a practice known as a Loan Modification. Lenders believe that by taking the hit now they can improve their chances of being repaid. Over the next few years banks and other lenders will be sorting through endless of mortgage modification applications. The approval rate of mortgage modifications in the second quarter of 2009 was 10%, which is a 7% jump from the first quarter, based on a Office of the Comptroller of the Currency Report.

Lenders now have the capital to justify mortgage modifications because of their balance sheets have strengthened with an influx of federal handouts. The Obama administration announced plans to help troubled homeowners in March. The plans include financial incentives for mortgage-servicing firms that modify home loans. But, the plan involved giving billions of dollars to strapped banks with very few strings attached. Ultimately it has taken until now for the banks to use the federal hand-out as an incentive to modify loans. Obama's critics cite that banks should have never underwritten loans on a stated income basis, and that many home buyers should have known that the homes were beyond their means. Obama's plan has been very controversial, because many see it as using tax dollars to ultimately bail out these two irresponsible parties.

Around a half million loan modifications are on record in the second quarter of this year, and one in ten of those involved reducing the principal. Even with this help, some homeowners are beyond help. This is often a sign that the mortgage was irresponsibly approved and processed. A whopping 28% of the mortgages modified in the first quarter of 2008 were in default again within three months. Also, of the loans modified in the second quarter of 2008, 56% were in default again a year later.

The most common procedures in loan modifications have been to either lower interest rates or extend the term of the home mortgage, similar to the goal of a mortgage refinance. These methods help homeowners without requiring lenders to lower the principal owed. The last resort for any bank is to write off some of the mortgage altogether, but this is happening in some cases. Lenders first try to modify mortgages by lowering the interest rate for qualifying borrowers. If that doesn't lower the payment enough then the bank may extend the term of the loan, which will lower the monthly payment even more.

Despite of the home loan modification efforts of banks, foreclosures still continue to rise. In a report last week, an estimated 12% of U.S. homes with mortgages will be in foreclosure over the next couple of years. The report said that mortgage modification efforts are not expected to slow or stop the problem, mostly because so many people default again. Because of the rate of defaults after a mortgage modification, many believe that the governments involvement is just slowing the inevitable. In the end, all of the irresponsible lending and borrowing would have fixed itself quicker without government resources.