Are Loan Modifications Helpful?

A new report from bank regulators shows that lenders are starting to lower the principal amounts 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 wading 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.

Banks now have the capital to justify loan modifications because of their balance sheets have stabilized with an influx of government cash. The Obama administration announced plans to help troubled homeowners in March. The plans include financial incentives for mortgage-servicing firms that modify loans. But, the plan involved handing over billions of dollars to strapped banks with very few stipulations. Ultimately it has taken until now for the banks to use the government hand-out as an incentive to modify mortgages. Obama's critics say 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 criticized because many see it as spending tax dollars to ultimately bail out these two irresponsible parties.

Almost a half million mortgage 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 just can not be helped. This is often a sign that the loan was irresponsibly approved and processed. Over one quarter of the loans modified in the first quarter of 2008 were in default again within three months. Also, of the mortgages 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. These methods help homeowners without requiring lenders to reduce the principal owed. The last resort for any bank is to write off some of the mortgage altogether, but this is happening in about ten percent of cases. Banks first try to modify loans by lowering the interest rate for qualifying borrowers. If that doesn't lower the home loan payment enough then the bank may extend the term of the mortgage, which will lower the monthly payment even more.

Despite the loan modification efforts of lenders, 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 few years. The report said that mortgage modification efforts are not expected to significantly ease the problem, mostly because so many homeowners default again. Because of the rate of defaults after a loan modification, many say 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.