A loan modification is an agreement between a lender and a borrower to change the original terms of a loan in order to make payments more affordable. This can be accomplished by temporarily or permanently reducing the interest rate on a loan or changing an adjustable interest rate to a fixed interest rate. Another method of loan modification is to increase the term of a loan from the standard 30 years to 40 years or longer. In some cases, the lender may also reduce the principal balance due on a loan. All of these changes result in a lower monthly payment for the borrower.
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Loan modifications are becoming increasingly common as the declining housing market and struggling economy take their toll on homeowners. Furthermore, the reduced standards for lending which contributed to the real estate boom are now causing problems as some borrowers are unable to afford payments on their loans. The reduced lending standards of the recent past included many programs where the borrower was approved for a mortgage either without disclosing income or based on unverified stated income. In these cases, the lender is not able to offer a realistic loan modification to a customer without currently verifying the income.
Recently, there has been political pressure for lenders to implement systematic programs to modify loans which are in default or facing a threat of default. The FDIC, the federal agency which insures most bank deposits, recently proposed a plan which would provide incentives for loan servicers to implement a systematic and sustainable process of loan modifications for loans at risk of default. The program guidelines specify that this is not a "social program" and that a loan modification will only be done in circumstances where the borrower can successfully document the income necessary to successfully maintain the modified loan payment. Estimates are that this program may save from foreclosure as many as 50% of those currently unable to maintain their pre modified mortgage payments.
The FDIC has been aggressively modifying loans for customers of Indy Mac bank which they recently took over. Many of the customers offered loan mods by the FDIC have accepted the offer of lower payments. If the results are successful over time, it is likely that modifications will be offered more freely by other banking institutions. The success of the loan modification effort will likely be gauged by determining how many borrowers remain current with their new lower payment. Initial results for loan modifications are encouraging but the ultimate success cannot be judged until data is compiled on the payment history over a period of years.
When successful, a loan modification provides benefits for both the lender and the borrower. The lender will avoid potentially greater losses on the loan by modifying the payment. If a loan defaults and the lender must foreclose, the costs of the legal work and losses on the homes sale would usually outweigh the costs of a modification. The borrower receives the benefit of a lower monthly payment, which should help him retain ownership of the home.
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