Loan Modifications, Workouts and Write-Downs

A loan modification is basically changing the terms of the loan. It’s a major change, such as changing the interest rate or the number of payments on the loan. For example, if the lender allows the borrower to go from a 30-year loan to a 40-year loan, this could reduce the monthly payment amount and extend the life of the loan.

In the past, rising prices of properties provided borrowers with significant increases in home equity. Typically, borrowers would refinance their homes before the loans reset. However, refinancing is almost impossible in a down market because of continuing falling prices, no equity or negative equity, and tight underwriting from most lenders.

In 2008, we had 3,157,806 foreclosure filings, up 81% from 2007. The loan modification programs we have seen so far are not working. The Federal Housing Administration’s (FHA) Hope for Homeowners Program thought they would be able to help about 400,000; they actually had 451 applicants and modified 25 loans. The Federal Housing Finance Agency (FHFA) loan modification program has done better, completing 5,600 for this past October and 8,291 for November. In the first nine months of 2008, an average of 4,948 modifications was completed through FHFA. FHFA is also working with borrowers who are eligible for the Streamlined Modification Program (SMP), implemented December 15, 2008.

Lenders and the government need to implement a loan modification program that will deal with principal reductions. In other words, a write-down of principal, along with an interest rate reduction, is needed. The Federal Deposit Insurance Corporation’s (FDIC) “Mod In A Box” loan modification is getting closer to what is needed, but a permanent write-down of principal will be required for many borrowers to be able to consider it. Lenders would need to determine the amount they will lose in the foreclosure process and work with the borrower to write-down the principal to an amount less that what they would lose through foreclosure, but what will still be affordable to the borrower, AND acceptable to both.
http://www.fdic.gov/consumers/loans/loanmod/loanmodguide.html

Loan workouts and modifications have a slim chance of working to truly stem the massive number of foreclosures without a reduction in principal closer to the amount of equity loss.