The Flaw In The Government's Mortgage Modification Program

Although the government has attempted to help homeowners stay in their homes by modifying their mortgage, this has done little to slow the flood of foreclosures. Andrew from the blog Blown Mortgage explains a critical flaw in the government's loan modification program. Continue reading to learn more:

Despite the governments efforts to provide loan modifications for individuals and families in financial difficulties that are at risk of foreclosing on their loans the mortgage aid seems to be moving too slow for all the families to benefit from it.

This has made many experts to question why banks are moving so slowly to take advantage of a program that is designed to help both the borrower and the lender. The idea is that mortgage modifications benefit both borrowers and lenders as they allow banks to receive payments they would not get if the mortgage foreclosed in a buyers market where the security (normally the house itself) is in negative equity.

However recent research quoted in today´s Washington Post indicates that this only holds true with a certain kind of borrower, the type of borrower that truly can´t pay the monthly mortgage payments at the current level but would be able to pay them if the monthly payments were reduced. This is only one of three types of borrowers though. It seems that with the other two types of borrowers, loan modifications are just not cost effective.

These two types comprise:

1) Borrowers that are in such financial strife that no loan modification or mortgage refinance is going to help in the long run, ultimately they are going to have foreclose their loan.

2) Borrowers that can meet the payments even though this might mean serious financial difficulties, even losing their life savings.

Banks and lenders have little incentive to help either of these demographics of borrowers.

To illustrate imagine if you were a lender, a bank or even a private company that provided loans for a profit. Obviously you demand some sort of security to protect your investment in case the borrower cannot or will not pay, this could be jewelry, thee deeds of a property or a car. Then one day the borrower tells you he is going through financial hardship and needs a break in his payments, a reduction in his debt or his monthly payments. However you realize that this borrower is not going to be able to pay his loan whether you help him now or not. Negotiating with him now is just going to cost you money in time, work and whatever reduction or break you provide for his loan. On the other hand you could simply foreclose his loan and claim the security without losing nearly as much. What would you do?

Even the kindest philanthropic can see the negative incentive that such a lender would have to actually negotiate a solution with the borrower.

Could this explain why loan modifications are moving so slowly despite the huge incentive programs the government is providing to encourage loan modifications on mortgages that risk foreclosure.

It seems that Obama´s administration has also seen this flaw in their system and is currently negotiating with banks for further incentives for the provision of loan modifications to the most vulnerable borrowers.

This article has been republished from Blown Mortgage, a mortgage news and analysis site.