Principal Reductions Increase in Loan Modsby Tim Manni
It seems as though some lenders may be ready to cut their losses and move on, as the number of lenders who have offered struggling borrowers a principal reduction has begun to increase. The majority of modifications so far have come in the form of interest rate reductions and/or loan term extensions. Until recently, flat out principal reductions were rarely a consideration:
The portion of loan modifications in the second quarter that involved reducing the principal jumped to 10% from 3.1% in the first quarter, according to the report released Wednesday by the Office of the Comptroller of the Currency, or OCC, which regulates national banks.
Since lenders exist to make money, convincing them to take a significant financial hit up front (as is required in a principal reduction), is a hard sell, especially during these trying times.
Over a year’s worth of loan mod data has proved that the popular modification strategies (interest rate reduction, loan term extension) haven’t worked well for the most part — redefault rates are still substantially high:
…banks and loan servicers are recognizing that modifications don’t always work if the borrowers aren’t given a big enough break. Of loans modified in this year’s first quarter, 28% were in default again within three months, the OCC said. Among those modified in last year’s second quarter, 56% were in default again a year later.
Translation: a reduced revenue stream combined with the high probability of a redefault has left lenders with few options. While a significant principal reduction can be costly, it helps to further lower a borrower’s monthly payment, and the addition of principal forgiveness improves the chance for a borrower to remain solvent.
It’s important to note that the OCC’s numbers regarding the increase in principal reductions only covers the first half of 2009. While we believe the use of principal reductions in loan mods will continue to increase, they’re unlikely to triple in the third quarter as they did in the second.
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