Sunday, February 22, 2009

Principal Reduction or Interest Reduction?

A concern raised with the Obama housing plan is it focuses on payment reduction instead of principal reduction. But a payment reduction based on a cut in interest rates has a de facto impact on principal. While par remains the same, the present value of the remaining payments falls. For anyone who doesn't need to move, this has the effect of reducing the amount owed (the mortgage) relative to the amount owned (the house).

As for those who do have to move, they are still stuck with the par value of the mortgage. On the other hand, a lower interest rate allows for more rapid amortization. An 8 percent 30-year mortgage with a 100,000 balance amortizes by about $835 in its first year, while a 5 percent mortgage amortizes by $1475. Not a huge difference, but every little bit helps.

10 comments:

Uncle Billy said...

What the planners either don't get, or pretend not to get is that we don't have much of a real economy, which means that the job losses are going to be biblical. Which means that it doesn't matter if you get the rate down to 0% *and* reduce the principal to $100.00 The masses are not going to be able to pay *any* mortgage, auto payment, or credit card bill. Don't believe this? Let's talk in a year.

Stress tests? They really think people are stupid.

Anonymous said...

While both principal modifications and rate modifications lower payments, I suspect that they have different effects in terms of future behavior for different borrowers. For example, principal modification may reduce default rates more than rate modifications for "cuspy" borrowers with current LTVs in the 90% to 125%. On the other hand, reducing interest rates may be a more effective form of mod for borrowers with very high LTVs (> 140%), since giving away principal may be more costly in terms of the default-weighted NPV of the loan.

Anonymous said...

In all honesty knowing first hand the current situation does not look good for many. I myself bought a home at the peak thinking the values would continue to increase and affordability would be out of reach. Little did I know what the future had in store. Principal reduction is the best way out of this for me. Otherwise I will be stuck in a home I did not intend to stay in for more than a few years with a growing family. In addition to reducing the principal, you are able to refinance to a more affordable payment. Sure the banks will take a hit. but if you consider the fact that I have paid over 60,000 to them and only 6,000 has applied toward the principal I am sure they will survive.

Anonymous said...

I agree. No one seems to look at the amount people have paid to the banks interest included. This is a subject that is a bit taboo.

Anonymous said...

Is this a taxable event? Would this amount be reported on federal (and state) income tax returns?
Is there a recapture clause? What happens when the property is sold? What happens if someone get their $300k loan reduce to $260k and four months later they sell the property for $270k? What happens when a $300k principle gets reduced to $260k and then the property is sold five years later for $320k? Maybe attaching a “lien” on the property until the loan reduction is paid back is the way to go (even if the lien can’t be paid on the first resale always have it on the property until paid back).
If by reducing rates to a reasonable %, extending terms (extend the life of the loan) and principle reduction (with a recapture clause) is not enough to keep someone in a home then too bad, you should have been smart enough to know what you were getting into.

Anonymous said...

I agree that I should have been smart not to get myself into the situation I am. What about the banks that lended the loan. They are the ones with all kind of MBA's to advise them. I am highly sure that they knew what they were doing. Let's be fair; we all made a mistake. Why then the banks should get our tax money to survive, but I and we should lose everthing. Is this fair?

Rudy said...

Hello, did you know that there is program that just came out that could reduce your pricipal, and refinance your house into a 30 year fixed at 6.25%? This is not a Loan modification! All Credit Qualifies, as long as you have a job you can reduce your principal.

Are you frustrated with values plummeting in your area?

Do you wish you could make that negative equity of $50,000 - $200,000 just disappear?

Has every Loan modification company in town told you that Principal Reduction is impossible?

What is it worth to you to have your Principal Balance Reduced to 90% of current market value?

We are the only company in the industry that has discovered the secret to Principal Reduction!

Please leave a detailed message as I do take a lot of calls for this program.

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Please only serious inquires, we are trying to help out as many homeowners as possible.

Wasting time = Homeowners losing their homes.
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