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October 1st, 2009

Principal Reductions Increase in Loan Mods

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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.

For more on this subject read:

Fannie Increases Credit Score Requirement
Homeowners in financial trouble often redefault

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2 Responses to “Principal Reductions Increase in Loan Mods”

  1. Mike Says: October 1st, 2009 at 11:14 pm

    There’s a lot of information there about loan modification programs but this article hits the nail on the head. I’ll share this information with anyone that needs it.

  2. Tim Manni Says: October 2nd, 2009 at 1:14 pm

    Hey Mike,

    Thanks a lot, we appreciate that!

    -Tim

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HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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