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Study reveals most successful loan modifications reduce principal

Federal Reserve Bank of NY Study reveals most successful mortgage modifications reduce principal

Borrowers who receive loan modifications that reduce loan balances and not simply interest rates are far less likely to re-default on their loans, according to a new study from the Federal Reserve Bank of New York.

While modifications that reduce monthly payments are far more likely to succeed than those that don’t result in lower monthly payments, how that reduced monthly payment is achieved matters, too, according to the study.

The Fed study is the latest to suggest that principal write-downs are more successful in avoiding re-defaults. Modifications that write down loan balances “can double the reduction in re-default rates achieved by payment reductions alone,” the study says.

Video Q&A Segment Discusses Latest Trends In Principal Reductions

Loan modification expert, Mike Rockwood, and author of the loan modification workbook I recommend, discusses principal reduction trends and programs offered by Bank of America and Wells Fargo in this video Q&A segment.

If you are not in the target group the banks are working with on principal reductions, you may consider using a hammer to motivate your loan servicer to negotiate with you, namely, a mortgage or forensic audit. This audit will document federal and state violations committed by the lender on your loan.

There are independent forensic auditors you can hire or a foreclosure defense attorney will likely have someone in their Rolodex.

The findings could have big implications on the government’s current loan modification effort, which focuses on offering incentives to borrowers and loan servicers, which collect and manage loan payments, to reduce monthly payments by lowering interest rates and extending the loan term.

(Although, the modification program doesn’t preclude principal forbearance or forgiveness on the part of banks, and borrowers who succeed in keeping up with their reduced payments can receive further incentives towards reducing their loan balance.)

But the program has been off to a slow start, and there’s considerable uncertainty heading into the new year over whether the program will be able to meet its ambitious goals to offer modifications to three to four million troubled homeowners.

The paper finds that principal reductions are more successful at avoiding re-defaults because they reduce negative equity and give the borrower a greater incentive to keep current on the loan. A loan modification that only reduces the interest rate, meanwhile, “creates an in-place subsidy to the borrower leading to a lock-in effect. That is, the borrower receives the subsidy only if he or she does not move.”

The paper takes a hypothetical borrower with a home that is worth around $30,000 less than the $200,000 mortgage on the home. In two different modification scenarios, the monthly payments are reduced by the same amount but produce different probabilities of re-default.

In a modification that reduces the borrower’s interest rate by 2.8 percentage points to lower monthly payments by 25%, the borrower’s probability of defaulting within one year is reduced by 11%.

But under an alternate modification that lowers monthly payments by 25% by reducing the borrower’s loan balance by 25% and through a slight interest rate reduction, the borrower’s probability of defaulting within one year is reduced by 26.5%.

The New York Fed paper says that borrowers who owe 15% or more than their homes are worth have a 51% higher risk of re-defaulting in any given month. The borrowers’ willingness to re-default also depends on “the prospect that further house price appreciation might bring the borrower back into positive equity.”

Before completing and sending in a loan modification package, you may want to obtain some coaching to combat the stall tactics banks/servicers are using to cut to the front of the line of other applications and get approved faster

Click here to get proven help with your home loan modification

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Technorati Tags: principal reduction, principal write down, home loan modification, loan modification, mortgage loan modification, loan modification program, hamp government program

Related posts:

  1. Lenders may be forced to use principal reductions as foreclosures rise
  2. FDIC Chairman Sheila Bair wants to force banks to reduce principal for homeowners on brink of foreclosure
  3. Bank of America planning more principal reductions to qualified homeowners
  4. Federal Reserve gave billions in secret loans to same big banks that deny and cancel loan modifications
  5. Q: How do loan modifications work?

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3 Responses to Study reveals most successful loan modifications reduce principal

  1. d karole on 26/06/2010 at 10:49

    have income units as well as residential properties. Submitted package to Chase for personal residence 2 weeks ago. Have contacted Chase regarding rental property.

  2. Terry Tran on 19/05/2011 at 12:11

    i have a home in California…i just modified my loan last yr. @Chase…@2% for the first 5yr. and 3%, 4%, 5% for next 30yr…that is great but my loan $350,000 right and my property is worth about $180,000 or so…i want to do a principle reduction, and i don’t know if that’s possible??? let me know … thanks

  3. Gail Simmons on 11/07/2011 at 08:16

    You should fight for a principal reduction. You will need legal leverage to do so using a mortgage audit and a securitization audit to get them in legal hot water.

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