Why Banks are Reluctant to Modify Mortgages

With the recent downturn in the economy, and increasing reports of foreclosures and people walking away from their mortgages, the idea of help for individuals who cannot pay their mortgage has been at the forefront of the news media.  However, banks and lending organizations have not been quick to modify mortgages for troubled homeowners, leading to the foreclosure rate continuing to rise in many areas where homeowners are “under water” in their mortgage and owe more than it is worth.  So why have banks been reluctant to embrace mortgage modification?  Wouldn’t it seem to make more sense to a lender to get some return on their money rather than go through the lengthy and expensive legal process of foreclosure?

Understanding Banks and Mortgage Modification

The simple reason why banks are reluctant to modify mortgages to avoid foreclosure is that it is not cost effective for them.  It just doesn’t pay.  By proceeding with the foreclosure process and then re-selling the house on the open market, a bank can typically make more money with less risk than if they were to modify the homeowner’s interest rate by dropping it by a percentage, or if they were to reduce the principal balance owed by the homeowner in an attempt to help the homeowner continue to stay in their home.

Let’s take an example of a homeowner with a house worth $150,000 who owes $175,000 on a mortgage.  If the bank forecloses on the home and can re-sell the home for $130,000 as a distressed foreclosure property or in a short sale, the bank will have made the interest on the original mortgage, plus they will be able to recover most of the home’s value.  If they reduce the rate of the mortgage to $150,000, they lose $25,000 instantly, plus the interest on that $25,000 over the remaining term of the mortgage, which could be tens of thousands of dollars in total. 

Another reason why banks are reluctant to modify mortgages is that there is a very real risk to the lender known as “redefault risk,” meaning that if they do modify the mortgage in some way to help the homeowner keep the home, there is a possibility that the homeowner will still not be able to pay the mortgage and will fall behind and re-enter the foreclosure process in the future.  In the meantime, the bank has lost even more money because the home may be worth less, and they are still owed the money on the mortgage by a homeowner who has proven incapable of paying in the past.

Getting Help

If you need to modify your mortgage, your best bet is to speak with an experienced attorney. He can assist you in negotiating with your bank to make it more likely that your bank will be willing to work with you on a mortgage modification plan that lets you keep your home.