Today many homeowners are facing a situation they never imagined for themselves – the prospect of losing their home through foreclosure. Whether the cause of the problem is loss of a job, sickness or death in the family or any of hundreds of other possible mishaps, the result is the same. These desperate homeowners are looking for a way to keep their homes. “Loan modification” is frequently brought up as a solution, yet most homeowners don’t really understand what that term means.
Technically, a loan modification is any change at made to the terms of the original loan agreement between the borrower and the lender. In practice, a loan modification should create a situation where the homeowner can once again afford to make the scheduled payments on their home. This is in the best interests of both the homeowner and the lender. Contrary to the belief of many homeowners in trouble, lenders DO NOT want to own homes.
There are 4 basic areas where loans can be modified in order to help homeowners avoid foreclosure.
1. Lower the interest rate on the mortgage.
During the recent real estate boom years many people bought houses using Adjustable Rate Mortgages with relatively low starting interest rates. However, these low start rates lasted only a short time before jumping up to much higher rates at the end of the introductory period. The rates often increased even though current interest rates went down! In addition, many borrowers used higher interest rate subprime mortgages to finance their home purchases. At the time these mortgages were popular, most people assumed that rapidly rising real estate values would make refinancing easy at the end of the introductory interest rate period. Unfortunately, real estate values crashed and refinancing became impossible for many people. One of the most common forms of loan modification involves the lender lowering the interest rate on the mortgage and/or converting the loan to a fixed rate mortgage.
2. Reducing the principal balance.
Although much less common than interest rate reductions, principal balance reduction is another method used to make the loan viable for the borrowers’ economic situation. Since real estate values have dropped in most areas, if a lender forecloses on the home, they are facing tens of thousands of dollars in losses in many cases. These losses don’t include the costs of foreclosure and ownership of the home for the lender. So a lender often stands to lose less money by simply reducing the borrower’s principal balance rather than foreclosing. Unfortunately, legal technicalities sometimes make it difficult for servicing lenders to modify the loan in this manner.
3. Extending the term of the loan or re-amortizing the loan.
Lenders can accomplish this by increasing the number of years above the term the original loan was amortized for. For example, a 15 year loan can be increased to a 30 year loan, or a 30 year loan can be changed to a 40 year loan. In cases where a borrower has already made payments over a substantial portion of the original amortization period, the loan can be re-amortized using the new principal balance and the original term.
4 – Waiving penalties and capitalizing delinquencies.
Homeowners in trouble often begin to pile up late fees and penalties on their accounts, thus increasing the difficulty of catching up their payments and bringing their account current. Lenders may choose to waive these fees in order to help the borrower keep the home and avoid foreclosure. Lenders can also “capitalize” late payments, which means adding any missed payments back to the principal and considering the loan current on the lender’s books.
Although these methods of modifying loans to make them more affordable and avoid foreclosure are beneficial for both the borrower and the lender, most borrowers still have trouble getting a loan modification approved. Most lenders are still not set up to efficiently process loan modification requests. Yet with a little preparation and a lot of persistence, troubled borrowers can still get their loans modified and avoid foreclosure.