Before opting for any mortgage modification, it is necessary to consider mortgage modification pro’s and con’s. The biggest advantage of mortgage modification is that it is possible to reduce equated monthly installments (EMI) with it. Because of this reduction of EMI, outflows from the borrower’s monthly income can be brought down. As a result, the borrower may find it easier to manage his finances.
A mortgage is deemed as modified when lenders and borrowers mutually change the terms and conditions of the original mortgage. It is primarily the lender who has to agree to the revised terms and conditions under the mortgage modification.
Two major aspects may be changed in such mortgage modification. These are:
* The interest rates and
* The repayment period
If a borrower is desirous of reducing EMIs, then lenders have a choice to reduce interest rates or extend the mortgage repayment term. At times, the lender may lower interest rates and also extend the term for repaying the mortgage loan.
From the borrower’s perspective, the mortgage becomes more affordable and therefore he/she can avoid any financial problems that could have led to their credit report being affected. Moreover, if the repayment period is extended, the value of money that will be spent in the future towards mortgage loan EMI would be much lower. This is because equated monthly installments remain uniform throughout the mortgage term. But the value of this money (i.e. the purchasing power of this money) keeps on decreasing because of annual inflation. Because of this, the effective interest that is being paid to the lender is much lower.
For assessing the benefit, all present and future EMI s can be discounted at an estimated rate of inflation, and their net present value can be determined. The difference between the outstanding mortgage loan amount and this NPV of future cash outflows through EMI’s, is the amount of interest that will be paid to the lender. This is certainly much lower than the amount of interest without discounting EMIs. The borrower can also spread the tax deduction advantage over longer period if the present income is not allowing him to utilize the maximum limit. As years go by, the borrower is likely to find it easier to pay the EMIs, because his/her income will increase, but EMIs will stagnate.
From the lender’s perspective, it saves on costs of foreclosure proceedings. Even if the lender chooses to foreclose the mortgage, it is not guaranteed that the sale proceeds will be adequate to cover loaned amounts; therefore, the lender does not seem to have much choice but to accept a mortgage modification. In addition, foreclosure proceedings and bankruptcy proceedings take time. The lender may have to wait till the house is sold, and sale proceeds are received. In the period in between, the lender does not get any interest on the amount loaned. The lender factors in these losses and accepts the revised terms and conditions as may be proposed by the borrower. At times, the lender may even accept to absorb some losses. In such cases, lenders may choose to inform credit agencies of borrower’s inability to pay the loaned amounts-this can affect the borrower’s credit score.
In view of these mortgage modification pro’s and con’s, both parties to the contract will be willing to modify the terms and conditions of the mortgage. However, borrowers should not become complacent again, as the lenders most likely will not be willing to extend similar modifications in future. Lenders also try out the mortgage modification plan that the borrower has proposed during the trial period, to check whether the borrower is truly able to adhere to the revised terms of the mortgage repayment.
It is in the best interest of borrowers and lenders to work together to modify the terms of the mortgage.