Some lenders are starting to write down the principal for some homeowners in trouble, according to a story in this weeks edition of Business Week. Mortgage work-out solutions in the past have just addressed the interest side of loans, giving very little to homeowners who now owe significantly more than the present market value of their home.
Banks can either forgive part of the principal or merely defer it. If principal is deferred, the homeowner must pay back the full amount of the loan when he sells the house. If the house doesn’t sell for enough to cover the balance, the homeowner has to pay the difference. Such a solution may just push the problem down the road for many people.
It is still rare for banks to forgive or defer principal. But in the 3rd quarter of 2009, 3% of the total mortgages that were modified included principal modification–either reduction or deferral.
The writers of this article didn’t mention the effect of mortgage write-downs on the homeowner’s credit. It is likely such a new concept that the rules of the game have yet to be established. I will venture a guess, however, that the effect will be similar to that of a short-sale: that is, it will not be the train wreck that foreclosure can be. But it will have a significant impact on the credit score.
