How to Best Reduce Principal Through Loan Modification

A loan modification is for those facing a financial hardship such as unemployment, serious illness or a substantial increase in debt. If you meet the qualifications, your mortgage loan interest rate will be reduced, which lowers your monthly payments. When payments are made, more money goes toward your principal balance, which reduces the balance quicker. You can apply for a modification by calling your lender to get the details. An application and affidavit will need to be completed. Your lender will also need verification of your income.

Instructions

1. Review the terms and conditions of your loan. Take for example, a 30-year mortgage loan in the amount of $200,000 with an interest rate of 8 percent and monthly payments of $1,467.53. When payments are made, a portion is allocated towards the principal balance and part goes towards interest.

2. Calculate the breakdown of principal and interest before the loan modification. Take the interest rate and divide it by the number of days in a year, (assuming each month has 30 days), and multiply the result by the number of days in the billing cycle, (30), and multiply times the balance, (.08/360 x 30 x $200,000), equals $1,333.20. The amount of the payment going towards interest is $1,333.20 and the portion allocated towards the principal balance is $134.44, ($1,467.53 - $1,333.20 = $134.44).

3. Calculate your results after a loan modification is completed. If your interest rate is lowered to 3 percent due to the modification, you will see a completely different break down of principal and interest, (.03/360 x 30 $200,000). The amount of interest will be $499.80.

4. Get an online mortgage calculator from Bank Rate or another such site, and enter the terms of the loan to get the new mortgage payment. After the modification, the new loan payment will be $843.21. The principal payment will be $343.41, ($843.21 - $499.80). If you can pay more than your standard payment each month, you will see your principal balance reduced sooner. This example assumes the payment in Step 1 has not been applied to the mortgage loan.

5. Get an extension of your mortgage. If the lower interest rate does not provide you with a comfortable, affordable payment, some lenders will extend your mortgage term to 40 years. If your payment is still not affordable, lenders have the authority to eliminate or reduce a portion of your principal balance. There is no guarantee that a lender will have your balance reduced or forgiven, according to Making Home Affordable. If a portion of the mortgage balance is forgiven, you will not have to repay it. This process can vary from lender to lender.

Tips & Warnings

• If your current mortgage payment is more than 31 percent of your gross monthly income, you may qualify for a loan modification, (including interest, taxes, insurance and principal), according to Making Home Affordable. Your interest rate can be reduced until the 31 percent payment is achieved. An interest rate can go as low as 2 percent to achieve this result.

• Some lenders will push a portion of the principal to the end of the loan maturity.

• A mortgage needs to have originated before January 1, 2009 to qualify for a loan modification.

References

• Making Home Affordable: What Will the Servicer Do through HAMP to Get My New Modified Payment Down to 31% of My Gross Income?
• Making Home Affordable: Request a Home Affordable Modification