Capitalization & Mortgage Modification

High mortgage interest rates and fees can place homeowners in financially strapped situations that put them at risk of default. Homeowners facing foreclosure or loan default may benefit from the options available through mortgage modification plans. And while capitalization of interest rates and fees can in some cases contribute to the problem, some modification plans use capitalization as a way to modify the existing loan terms.

A mortgage loan modification can give homeowners a new start in cases where missed mortgage payments and late fees become too much to handle. Mortgage modifications are offered through a homeowner’s existing mortgage lender. In some cases, lenders will consider a modification plan in order to avoid a loan default. In effect, a modification plan restructures the terms of an existing mortgage and makes the payment terms more affordable for the homeowner. Certain types of mortgage loans, such as adjustable-rate-mortgages (ARMs) and interest-only mortgages, can carry high interest rate charges and fees, which places borrowers in a position where a mortgage modification plan is necessary.

Capitalization has to do with how the interest charges on a mortgage loan are applied when these charges go unpaid. With a traditional mortgage loan, the monthly mortgage payment covers the principal loan amount as well as interest charges for the month. With nontraditional mortgage loans, loan terms may allow homeowners to make minimum monthly payment amounts. Oftentimes, minimum monthly payment amounts only cover a portion of the interest rate charges for the month. In these cases, the conditions of the loan may allow lenders to add any unpaid charges to the principal loan amount. In effect, homeowners end up paying on a loan amount that continues to grow, which results in larger and larger monthly mortgage payments.

Interest rate modifications on a mortgage loan provide a flexible method for adjusting an existing loan structure. Interest rate reductions allow for a smaller monthly mortgage payment overall, even in cases where capitalization from unpaid monthly interest charges have increased the total loan amount. Another option involves freezing an existing mortgage interest rate. This method helps to reduce or at least contain monthly mortgage payment amounts. For homeowners who have adjustable-rate-mortgages, loan terms may include periodic reset periods where interest rates adjust according to current market index rates. ARM mortgages also may have monthly margin or finance costs that add to any interest rate increases. By freezing an existing interest rate, monthly mortgage payments remain unaffected by market index rates and margin costs.

Principal loan amount modifications allow lenders to reduce monthly mortgage payments or reset the total loan amount by adjusting the principal amount due on a loan. One way of doing this -- known as a capitalization of arrears -- involves tacking any unpaid interest, missed mortgage payments, fees and late charges onto the principal loan amount. This method may very well increase the monthly payment but provides homeowners with a new start in terms of keeping up with their mortgage payments. Extending the loan term is another method used by lenders to readjust the principal loan amount. This method involves extending the principal amount owed over a longer payout period, such as going from a 30-year to a 40-year mortgage term. In effect, homeowners end up paying a smaller monthly payment for a longer period of time.