Do Loan Modifications Raise Debt?

Could it be that loan modifications are actually raising debt? I read a short article today by Dean Calbreath in the San Diego Union Tribune that stated yes, they are. Mr.Calbreath points out that more foreclosures could be prevented if, instead of increasing the debt on the principal of troubled mortgages, the lenders reduced the principal. This makes sense, right?

A study released last week by a Federal Reserve branch points out that principal reductions over time have a lower chance of loan redefaults than do those with mere payment changes. But this scenario is not the case in the majority of modifications. The norm is for the lender to reduce payments only, rolling any missed payments into the loan balance. This is obviously a problem, especially for those living in homes where the value has dropped substantially. It’s simple logic: if you are given a loan modification based on current market value, meaning not only your payments but your principal balance is reduced, you may be more motivated  to keep making payments.

This refusal to follow logic will not only limit the effectiveness of loan modifications, but will lead to more foreclosures down the road. According to the recent study the current loan modification practice tacks on  between $7400 and $8160 to the balance of the loan. So, you ask, why are the lenders not following this logic? That seems to be another million dollar question in the sea of million dollar questions when referring to lender behavior over the last several years.

The potentially good news is that the current investigation into how banks handle loan modifications and foreclosures may have some bearing on future cases. Currently less than 40% of the potential foreclosures in San Diego county have been prevented through permanent loan modifications this year under the federal HAFA program. Maybe reducing the principal on troubled mortgages will be the new foreclosure prevention method that helps get that number up.  I sure hope so.

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