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Ever wonder why loan modifications dont work?
When most people hear the phrase “loan modification” there are a multitude of images and emotions that flood the brain; skepticism, hope, desperation, lonely, gamble, fear and maybe even a “yeah right”!  I have often said that it’s easier to catch a Leprechaun at the end of a rainbow than receive a permanent loan modification.

Using a loan modification to avoid foreclosure has gotten a lot of bad press lately and maybe rightfully so.  According to the U.S. Treasury Department reporting on the status of loan modifications in Obama’s Home Affordable Modification Program (HAMP) through December 2009:

The numbers just don’t lie and they are staggering!  The odds are almost as bad as winning the Lottery.  But when I look at these numbers, I share the same serious questions that homeowners ask me all the time “Why don’t they work?” and “What is the bank looking for? What is the secret formula?”  So I went on a search for the answer to those questions myself and here is what I found.

According to a large mortgage lender, the formula that they use is fairly simple to initially pre-qualify a homeowner for a loan modification.  When you add the current loan principle balance with all late payments, charges and fees together, if the total is less than the original loan principal, then you pass the first test.   Unfortunately in the lending world of 5 years ago when interest only loans were all the rage, no one has paid down their mortgage principle enough to make that formula work.   That’s the first big problem.

The second big problem with a loan modification is it’s not a principle reduction.  Meaning the lien holder is only agreeing to spread the payments out over a longer period or lower the interest rate to give you a lower payment, but not lowering the actual principal amount owed on the original mortgage.  That means if you have to move for some reason a few years from now, you still owe the full principle left on the loan.  This point alone illustrates how toxic loan modifications are and that they are really just delaying the inevitable in most cases.

The third and possibly most significant issue in the whole loan modification process is the investor.  Let’s assume that you fit the initial criteria set by the lender and you are put into a trial loan modification.  You make your payments one time every month for six months like they told you to, and then we all know what happens next.  The bank denies you and you now owe full payments for the last six months on top of the old late fees and other missed payments. WHY? Why were you denied? You did what they asked, right?  We all have someone we know to whom this has happened.  The reason is not the bank mostly, but the investor.  You see, most banks just service the loan and there is a separate party investing in the loan.  The investor is the one that ultimately decides whether he wants to grant you a loan modification or not.

Bank of America for instance, has over 1200 investors, for their mortgages.  So while Bank of America may actually want to give you a loan modification to avoid foreclosure, the investor ultimately can decide that it’s too risky and deny the loan modification.  Not many can blame them though considering some estimates say loan modifications are re-defaulting at a rate over 50%!

So while a loan modification to avoid foreclosure and help the homeowner to stay in their home may sound like a great idea, for now it may just be a pipe dream.

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