Loan Modification Should Include a Principal Balance Reduction

principal balance reductionDale Carnegie once said that “the only way to get the best of an argument is to avoid it.”  This is easier said than done if you’re currently attempting to get a loan modification from your bank.  Whether you are going it alone or paying for a loan modification no doubt you will experience some frustration.

 This may be because lenders don’t really want to modify your loan.  In an article from the Boston Globe yesterday titled ‘Lenders avoid redoing loans, Fed concludes’ economist Paul S. Willen said “loan modification is not profitable for lenders, if it were profitable they would go out and hire staff.”

 Now this isn’t entirely accurate.  The lenders are hiring staff and they are modifying loans.  How do I know this?  I recently interviewed for a position in the loan workout department of a very large lender that accepted billions in TARP money.  During my interview I was told that they are reducing interest rates AND principal balances. 

 My theory is that the banks are slowly starting to recognize that a loan modification should include a principal balance reduction.  Without one the borrower will inevitably fail.  A few weeks ago I was asked to speak at my church about loan modification.  I met a woman there who was able to successfully negotiate a loan modification on her own with Wachovia Bank.  This loan modification included a change in interest rate from 6.6% to 5.87%.  That’s obviously not enough to make her payment significantly more affordable.  The real help came with the $60,818 principal balance reduction she received.

 The reason the statistics on modified loan failures are high is because they don’t include a principal balance reduction.   Borrowers eventually realize that while their payment is more affordable the mortgage they have could take a decade or more to pay off.  Once this reality sets in they just walk away.  For example, it would take 8 years for a homeowner with a mortgage of $150,000 and a home value of $100,000 to be at break even.  And that’s at a 6% annual appreciation rate.

 My advice to colleagues, clients, friends and you is to fight hard for a loan modification which includes a principal balance reduction that is more in line with the market value of your home.  Without one you are likely to become another statistic.

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