What is a Mortgage Loan Modification?
Explaining Loan Workouts, Who Qualifies, & How Accessible They Are
Aug 26, 2009
With the housing market experiencing the most pervasive slump since the Great Depression and the number of home foreclosures on the rise, mortgage loan modifications have been getting a lot of attention lately- especially after the passage of President Obama's Housing Stimulus Plan. A mortgage loan modification can bring some welcome relief to those who qualify. But unfortunately, many homeowners will not be eligible for this program.
Here are a few things home owners should know about mortgage loan modifications:
What is a Loan Modification?
A mortgage loan modification, also known as a loan workout, occurs when a lender agrees to change the terms of a mortgage in response to a borrower's long-term inability to repay the loan. These changes may be permanent or temporary and generally involve a reduction in the mortgage interest rate (APR), a loan term extension, and a change in monthly payments. In some cases, lenders may even agree to allow the borrower to skip payments (and add them to the end of the loan) or reduce the total amount of principal due on the loan.
In short, the loan modification is designed to make the mortgage more affordable for the borrower so that foreclosure and bankruptcy can be avoided and the individual's credit rating can be preserved. In fact the ultimate goal of a modified loan is to help borrowers reduce their monthly mortgage payments to 31% of their gross income.
Why Would Lenders and Servicers Agree To Do a Mortgage Loan Workout ?
Banks and commercial lenders are generally not known for their ostentatious acts of goodwill towards their customers, so why would they agree to do a mortgage loan modification in the first place? The answer is actually quite simple: lenders would stand to lose more on a foreclosure versus a loan modification. If a borrower stops making payments and collection attempts have failed, then a lender can either try to repossess the property, write off the loss, or wait till the person declares bankruptcy- in which case the lender will receive virtually nothing. None of these options are so appealing.
Moreover, under President Obama's Housing Stimulus Plan, even mortgage servicers will benefit from a mortgage loan workout. Servicers will get $1,000 for each eligible modification they make, and another $1,000 a year for three years as long as the homeowner remains current on payments.
Who is Eligible for a Loan Modification?
According to President Obama's Housing Stimulus Plan, several situations may qualify an individual to receive a modified loan:
- Those with a high combined mortgage debt compared to income
- Those who are underwater- i.e. they have a combined mortgage balance higher than the current market value of their homes
- Those who are in imminent risk for default
Lenders and servicers will typically be focused on the borrower's ability to afford the terms of the modified loan. Some determining factors that a lender will consider include:
- The nature of the borrower's financial difficulty
- The borrower's ability to pay the modified loan
- The amount owed on the loan
- The amount of equity the borrower has in the property
Why Are Many Lenders and Servicers Not Approving Eligible Loan Modifications?
Even with all the documented evidence pointing to the fact that it will be good for the economy as a whole for banks and servicers to conduct effective loan modifications, many borrowers are receiving loan workout plans with terms and conditions that are proving to be unsustainable in the long run. Moreover, the rate of modified mortgage loan approvals over the past two years has been slow. Both banks and mortgage servicers have been dragging their feet in this area. Lately, the benefits of avoiding a loan default may be outweighed by other benefits, such as the collection of lucrative fees.
In short, a loan modification is a useful tool that can help many consumers struggling to stay current on their mortgage payments. But not everyone will be able to benefit from it.
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