Over the weekend I attended a birthday party. In talking with one of the guests, I learned that a year ago, her lender, Chase, had sent them, entirely unsolicited, an offer to modify her loan from an interest only loan to a 30 year fixed rate at 5 percent AND to reduce the principal amount of the loan by $117,000. She had an excellent payment history in all ways and this was Chase’s reward to her. When she sells her house, the $117,000 will be added to the 1099 she will receive, but, as long as she (and her husband) don’t net more than $500,000 profit from the sale of the house, there will be no taxable capital gain.
There are two key factors at work here. One, the excellent payment history and two, the toxic aspect of the existing loan. Interest only loans were popular because of the low monthly payment, but in a falling market, that unreduced principal becomes a risky proposition to the lender. Even borrowers with excellent payment records may begin to feel they are in a no win situation as they watch the value of an asset on which they owe money become worth much less than what is owed on it. In this case, Chase chose to make a preemptive move to keep this performing asset for turning into a nonperforming one.
Generally, the lenders who are offering these principal reductions are not the originating lenders, but, rather, purchased the loans at a reduced value – like Chase did with Washington Mutual. They are, therefore, in a position to make these offers without experiencing a significant loss. If you’re wondering why Bank of America doesn’t do more with the toxic loans it purchased from Countrywide, it’s because they paid close to top dollar for those loans.
Don’t expect this to be a trend, though. All the major banks have refused to consider modifying principals on 30 year fixed loans. It’s also not likely to happen if you are experiencing financial difficulty. I have some clients who would like to do an FHA short refinance on their fixed rate loan. An FHA short refinance is like a short sale, but without the sale. The first lien holder agrees to release it’s lien for the amount of a new FHA loan. The result is a new loan with a lower principal. The current lender, Wells Fargo, has told them that they would rather, foreclose, do a short sale or have the house burn down than do an FHA short refi. With no coherent policy, it’s no wonder we are all confused and angry at the banks.