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| US Banks are now More Likely to Offer Principle Reductions After Recent Study |
High post loan modification default rates are forcing lenders to reconsider their reluctance to grant principle reductions when they modify loans. A recent study showing that 50% of loans modified in the first half of 2008 were back in default within six months has lenders scrambling to figure out how to keep their borrowers current. A different study showed that 25% of modified loans were back in default after the first payment.
Principle reductions, up until now a somewhat rare occurrence in loan modifications, are increasingly being seen as a viable answer to reduce the size of borrowers’ monthly payments and to provide the motivation to stay current on monthly payments. Diane Pendley, Managing Director and Head of Fitch’s Operation Risk Group recently stated “Some combination of payment reduction and either principle reduction or forgiveness may be the most effective approach to loan modification as it may increase borrower ability and willingness to repay the modified amount.” She added “However, when principle reduction is used, as opposed to forbearance where a portion of principle is ballooned to the end of the term, it should be carefully considered and tied to the current value of the home.”
Data obtained from First American Loan Performance showed the principle reductions of 20% or greater cut the default rate to 28% from the overall rate of 50%. When monthly mortgage payments were modified lower by 20% or more the default rate dropped further the 21%. Smaller decreases in monthly payments ballooned the default rate to 49% within the first six months.
Principle reductions have also been mentioned prominently in the Obama administration’s unveiling of the “Homeowner Affordability and Stability Program” (HASP) where lenders can incorporate the reductions as part the new formula requiring limitations on the size of a homeowner’s monthly mortgage payment. The guideline for the principle reductions is set the loan to value at no more than 90% which, in areas where home prices have fallen hard, could result in big reductions for homeowners.
While much smaller in size, the HASP initiative promises yearly principle reductions to homeowners that pay their modified payments on time for at least one year. For up to five years, homeowners who pay on time will have the principle on their mortgage reduced by $1,000 per year.
What remains to be seen is how willing lenders, including FNMA and FHLMC, will be to make principle reductions on a regular basis. It could be that they will require more evidence that principle reductions can make a big difference in keeping homeowners current and motivated to stay that way. Common sense would dictate that the lower the monthly payment, the better the chance that the borrower will make that payment. Principle reductions could play a big role in that calculation. |
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