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New information from bank regulators shows that banks are starting to lower the principal balances due on home mortgages for some struggling borrowers, a practice known as a Loan Modification. Banks are betting that by taking the hit now they can improve their chances of being repaid. Over the next few years banks and other lenders will be sorting through endless of loan modification applications. The approval rate of mortgage modifications in the second quarter of 2009 was 10%, which is a 7% jump from the first quarter, based on a Office of the Comptroller of the Currency Report.
Banks now have the capital to justify mortgage modifications because of their balance sheets have stabilized with an influx of federal cash. The Obama administration announced plans to help underwater homeowners in March. The plans include financial incentives for mortgage-servicing firms that modify mortgages. But, the plan involved handing over billions of dollars to troubled banks with very few strings attached. Ultimately it has taken until now for the lenders to use the federal hand-out as a justification to modify loans. Obama’s critics cite that banks should have never underwritten mortgages on a stated income basis, and that many home buyers should have known that the homes were beyond their means. Obama’s plan has been very controversial, because many see it as spending tax dollars to ultimately bail out these two irresponsible parties.
Almost a half million mortgage modifications are on record in the second quarter of this year, and 10% of those involved lowering the principal. Even with this help, some homeowners are beyond help. This is often a sign that the mortgage was irresponsibly approved and processed. A whopping 28% of the mortgages modified in the first quarter of 2008 were in default again within three months. And furthermore, of the loans modified in the second quarter of 2008, 56% were in default again after 12 months.
The most common tactics in loan modifications have been to either lower interest rates or extend the term of the home loan. These methods help homeowners without requiring lenders to reduce the principal owed. The last resort for any bank is to write off some of the loan altogether, but this is happening in some cases. Lenders first try to modify mortgages by lowering the interest rate for qualifying borrowers. If that doesn’t lower the payment enough then the bank may extend the term of the mortgage, which will lower the monthly payment even more.
Despite of the loan modification efforts of banks, foreclosures still continue to rise. In a report last week, an estimated 12% of U.S. homes with mortgages will be foreclosed on over the next few years. The report said that loan modification efforts are not expected to slow or stop the problem, mostly because so many people default again. Because of the rate of defaults after a loan modification, many believe that the governments involvement is just slowing the inevitable. When all is said and done, all of the irresponsible lending and borrowing would have fixed itself quicker without federal resources.