Probably the one most often heard statement since the collapse of the real estate market in 2006 I've heard has been, 'Let the banks write down those loan balances!' This notion is now taking hold, as the article below reflects.

Once you read it, you'll see that any other measely effort towards loan modification is senseless. This is something the banks, which are fully backed up by Treasury, should do quickly and without hesitation.

from Blown Mortgage...

Loan Modification consultants have being saying it for a long time; the best loan modifications are those that reduce the balance of the loan. This might seem obvious; of course borrowers are going to prefer loan modifications that reduce the amount they owe. What is not so obvious is that these types of loan modifications may be the best kind for lenders too.

Loan Modifications can use a variety of tools and measures to reduce the monthly payments of a mortgage. Reducing monthly payments is considered to be the main objective of a loan modification, as a way of giving troubled borrowers a break so they can continue to pay their mortgage. This can be done by:

1) Reducing the interest rate of the mortgage, either temporarily or permanently.
2) Extending the term of the loan, which means giving the borrower longer to pay the loan back.
3) Rolling interest payments to the end of the loan, this reduces monthly payments but creates a huge payment at the end of the loan.
4) Principal reductions of the loan balance. Here the bank or lender “forgives” or writes off a portion of the loan.

The Obama Administration does not control which measures lenders use on loan modifications and they certainly don’t require lenders to cut mortgage principals, what’s more, until recently principal reductions seemed unthinkable, a nice idea but not very practical. It must be said that forgiving debts is a nice thing for friends to do, but it doesn’t sound like a good way for lenders to do business.

However, recent reports are showing that principal reductions could be a key factor in creating cost efficient loan modifications for both lenders and borrowers. One of these reports was published by the Lender Processing Services June 2009 Mortgage Monitor and concluded that re-defaults on loan modifications with a principal reduction element fare much better than those based exclusively on interest rate reductions. The report states that “the success rate for loss mitigation-related loan modification hovers in the 30-40% range, with a higher success rate for loan modifications involving a reduction in unpaid balance.

The success rates of loan modifications with principal reductions is so much better than with other methods that lenders are beginning to listen to the data and increasing their principal reductions on mortgages of troubled borrowers.

You might still ask yourself why banks or lenders would be willing to cut unpaid loan balances instead of using other apparently cheaper measures. The key, we hinted at above, are foreclosures. Foreclosures are expensive for lenders, selling in a buyers’ market and the costs associated with selling a property are not cheap. Having said that any kind of loan modification carried out to avoid foreclosure is expensive for lenders whether they reduce interest rates, extend the term of the loan or reduce the principal balance, what makes it even worse is when borrowers re-default on their loans after the loan modification. Because foreclosure re-defaults are much lower on loan modifications with principal reductions, lenders are starting to think they might be cheaper in the long run, which is good news for the fortunate few that actually qualify for a loan modification.