Fed says lenders should cut principal instead of adding to it
ORIGINALLY PUBLISHED DECEMBER 20, 2010 AT 3:14 P.M., UPDATED DECEMBER 20, 2010 AT 5:30 P.M.
Getting a mortgage modified can add thousands of dollars to the principal of the loan instead of reducing it, according to a study released today by the Federal Reserve branch in San Francisco.
The study found that "the continued reluctance of servicers to reduce principal balance may limit the effectiveness of modifications, especially in areas that have seen drastic declines in house prices."
Currently, when lenders modify home mortgages, it is typically through temporary reductions in the interest payments attached to the loan. But relatively few lenders reduce the principal of the loan, even though the principal may be far higher than the home is currently worth on the market.
Instead of reducing the principal, lenders often add to it by tacking on any loan payments that they borrowers failed to make when they were in default - which is typically a necessary precondition for getting a loan modification.
The Fed report says that borrowers might seen an increase in their loan balance ranging from $7,400 to $8,160.
The study found that "especially given the dramatic house price declines in California," reducing the amount of principal owed on a loan is an important way of preventing foreclosures.
"Research has shown that loans that include a reduction in the principal amount are less likely to redefault than loans with only payment changes," the study said, adding that "few borrowers are receiving principal reductions, and are instead finding that their missed payments are being rolled into their loan balance."
For a link to the study, which primarily focuses on how different ethnic groups cope with foreclosures, click HERE.
