Loan modifications that include principal reduction are becoming more common. Banks and lenders are modifying more mortgages, and as part of that process they are forgiven or deferring principal on the total amount of the home loan that is due. Both regional lenders and national banks are continuing to see the positive results from mortgage principal reductions, and they are seeing these programs as being an effective way to slow down and stop future foreclosures.
Many experts, including consumer mortgage loan advocates and housing counselors, continue to say that available information shows that the best way to help struggling homeowners is to reduce the principal balance on their loan. They have claimed that it is more effective than reducing interest rates or waiving fees. Now banks are increasing the percentage of loans in which they reduce the total principal that is owed. Last year, or even several months ago, this approach would have been unthinkable.
The federal government does provide information and they report on this data. According to statistics from the Office of the Comptroller of the Currency, loan modifications that also included principal reduction or write offs as part of the process increased from 3.1% in the first quarter of 2009 to over 10% in the second quarter of last year. The percentage has continued to increase from there. During the third quarter of last year the percentage of loan and mortgage modifications that involved principal reductions increased to almost 13%.
You may ask why would a bank offer this. Not only does information show that the number of foreclosures will be reduced by providing this type of assistance, but another big reason is the psychological one. Homeowners who are upside down or underwater on their home mortgage don’t have as much incentive to continue to make their monthly payments. Whether right or wrong, there are some borrowers who are not as aggressively making good on their loan obligation if the value of their home loan exceeds their home's value.
Studies also show that if a bank or mortgage lender reduces the principal amount of the loan to be less than the amount of home’s current value, the data shows that banks stand a better chance of receive more payments and a solid financial effort from the homeowner. Writing off principal will also reduce the number of home foreclosures, which are expensive for banks as well.
There are are a couple different variations to the programs. Banks can either decide to forgive principal on the loan outright or they may decide to defer it. Forgiven principal on a loan is basically reducing the total mortgage balance. So it is very straightforward. See below for an example.
However, in a deferral the borrower will need to pay back the full amount on the original mortgage when the homeowner sells the property at a later date. What some banks may require as well is that if the final sales price doesn’t cover the principal, the homeowner has to pay the difference between the sale price and the principal. So these types of deals are a less effective tool. Some deferrals may say the homeowner may need to pay back some funds only if the home value increases again at some time in the future.
To provide information on an example of how much you may be able to save, say you have a mortgage for $250,000 on a home and the value of the home has decreased to only $150,000. Your monthly payment may be somewhere around $1458.93. A successful principal reduction would reduce the mortgage balance to $150,000 (the value of the home), and it would also lower your monthly mortgage payment to about $923.58 per month, which is a savings of $535.35.
An increasing number of mortgage modifications from Wells Fargo include principal reductions. Last year the bank cut over $2 billion of principal on its customers loans. They have forgiven an average of $46,000 in principal on the mortgages that were modified. The San Francisco-based lender on average has in place a maximum reduction of about 20% on loans, however they have reduced certain mortgages by as much as 30 percent in some rare exceptions. This is just one of the resources they offer homeowners. Click here for more information on Wells Fargo mortgage assistance.
The program has also been shown to be effective. After the modifications of these home loans, the six-month re- default rate was about 15 percent to 20 percent. While that may seem high on the surface, in actuality that percentage is less than one half of the industry average. So the approach is very effective. Wells Fargo is a big proponent of offering principal reduction if that option makes sense for that individual borrower’s personal situation, according to its chief financial officer.
Another major lender, Citi, has also both streamlined and improved its existing loan modification program and they have increased the number of mortgages and home loans with principal reductions. They tried to come close to the program that is offered by FDIC/IndyMac model, which is an aggressive approach to reworking delinquent loans and helping struggling homeowners. Much of the relief they are providing is part of the Citi Homeowner Assistance program. Read more.
The principal reduction program uses an effective and simplified formula to determine an affordable payment for the homeowner that is based on a percentage of the borrower's gross income. After they have that amount, Citi will then reduce the monthly payment on that mortgage to that amount. And more and more of these reductions are including forgiveness of principal in addition to interest rate reductions.
If you are having trouble making your mortgage payments, and if you are a former Countrywide or Bank of America customer, then the BOA has programs for you. They offer home loan modifications that will attempt to set your payment based upon what you can afford to pay and your current income. A big part of their program involves principal reduction. In particular this is an option that is offered on adjustable rate mortgages and on pay-option home loans. Many of the principal reductions are offered as part of the Bank of America National Homeownership Retention Program, and they also have several other options for homeowners.
While unfortunately many banks and lenders don’t want word to get around that they reduce principal for certain homeowners as they fear that borrowers who can now currently afford their payments will demand better deals, or stop paying. However, the truth is they do offer these programs. You can work with a professional, or directly with your lender, to explore how you can benefit from mortgage principal reduction assistance programs.
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