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HAMP 2.0: Are Principal Reductions a Better Deal?

Posted by  on Aug 22, 2010
 

Mortgage borrowers who are eligible for the Home Affordable Modification Program (HAMP) may benefit from recent changes that partially compensate lenders for reducing the principal balance on certain home loans. Typical HAMP eligibility qualifications include:

  • Living in the home as a primary residence
  • A mortgage of $729,750 or less
  • The mortgage was originated on or before January 1, 2009
  • At risk for default due to hardship

Underwater? Stay Afloat with a HAMP Principal Reduction

Mortgage lenders or servicers who participate in HAMP will be required to consider writing down some of your principal if your mortgage balance exceeds 115% of your property's value. Mortgage lenders will get extra incentives for offering principal reductions as part of HAMP mortgage modifications. This principal reduction alternative can help you recover some of your lost equity as long as you remain current on your modified payment.

Under this plan, mortgage lenders may drop your loan balance as needed to reduce your payment to no more than 31% of your gross income--as low as 115% of your property value. Even better, you don't pay interest on the amount written down. So, if you started with a $200,000 mortgage on a $300,000 property, and it is now a $150,000 property, you may be able to get a principal reduction to $172,500 (115% of $150,000).

After three years, if borrowers make their modified payments on time, the mortgage lenders permanently forgive this amount in three equal installments over 3 years. Thus the principal reduction of $27,500 ($200,000 - $172,500) would be forgiven at $9,167 per year for the subsequent three years.

When Principal Reduction Isn't Such a Great Deal

However, not everyone derives the best benefit from this alternative. If you aren't severely underwater (say, you owe $200,000 on a home worth $180,000), you wouldn't even be eligible for a principal reduction, because 115% of your home's value would be $207,000.

In fact, if you plan to keep you home for a long time and are not severely underwater, reduced mortgage rates may save you a lot more money over the long run. Alternatively, if you'd like to just sell that home and get out, a principal reduction may help you do so without resorting to a short sale.

Are Lenders Required to Reduce Your Principal?

Frankly, no. The purpose of the HAMP program is not to simply hand out free home equity--but to give back enough to keep homeowners in hard hit areas motivated enough to keep paying their mortgages. HAMP simply offers financial incentives to participating lenders to do so, who typically evaluate potential HAMP-related modifications with an NPV test. An NPV test helps calculate whether the lender is likely to lose less on a risky loan by modifying the loan, foreclosing, or doing nothing at all.

When principal write-down is least risky according to the NPV test, it is rationally expected that lenders will provide the principal write down alternative when you qualify for it. However, the simple reality is that those homes that are severely underwater are less likely to pass--so not all HAMP-eligible loans are likely to even receive a reduction offer from the lender.

What About Homeowners Who Already Got a HAMP Loan Modification?

Homeowners who already received a HAMP loan modification might be able to apply for principal reductions, but that decision still depends on their mortgage lenders. However, increased incentives will be available to loan servicers that decide to review previously-modified loans. If your loan servicer is a HAMP participant and so chooses, you may be able to get this newer loan modification option instead of your old one.

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