Loan Modifications may only be a Bandage for Foreclosures

Many critics-especially those who stand to lose money when mortgage restructuring occurs-say that loan modifications may only be delaying inevitable foreclosures. They argue that loan modification can mask problems temporarily, but can't make those troubles go away.

Mortgage restructuring through loan modification allows homeowners to receive more lenient terms on their home loans. These may include lowered interest rates, reduced principal, or longer amortization periods in order to stretch the life of the loan more than 30 years, thereby reducing the size of each monthly payment. Sometimes, homeowners facing foreclosure can do a loan modification to help bring the amount of their payment more in line with their current income.  This could be enough to enable them to stay current with mortgage obligations and remain in their homes. The results are good for both lender and borrower alike because the foreclosure process costs banks money and creates a whole slew of personal and financial problems for families who must forsake their homes.

Loan modification postpones problems

Unfortunately, opting for a mortgage refinance to avoid foreclosure may be much less successful in the long run than proponents of loan modification would like to believe. According to a 2007 Fitch Ratings report, between 30 and 40 percent of borrowers who were granted loan modifications still defaulted on the newly modified loans within two years. Research from Moody's and other firms regarding both prime and subprime mortgage restructuring strategies confirms those findings, and makes many economists worry that loan modification only postpones the inevitable foreclosure without fixing the underlying cause.

Mortgage restructuring good for banks

Nevertheless, Fed Chairman Bernanke is pushing for loan modifications.  He suggests that the federal government is ready and willing to do more to help back the types of mortgage restructuring efforts already supported and implemented by the FDIC. As the FDIC takes over the loan modification programs of failed institutions, they're trying to rework loans to a level that makes the payments not more than 38 percent of a homeowner's monthly income. This is especially helpful these days, as people tighten their budgets and fight to make ends meet. Loan modifications also give lenders a chance to upgrade delinquent loans into the status of current performing loans, which improves their balance sheets and frees them up to do more lending.

Those who service mortgages, and many who invest in them by providing the cash to make these real estate loans, are skeptical, however, and say that loan modifications are a bad idea. They prefer to go through with foreclosures and recoup their costs, complaining that delaying foreclosure auctions only makes matters worse. Homeowners already in serious financial trouble aren't going to be able to catch up during this historically poor economy, they theorize.  They also believe that it's smarter to stop tinkering with mortgages and to simply accept the painful consequences now, not later, when they may come back to haunt us.