I’m not a financial expert, but has this situation ever been tried to reduce foreclosures? If so, what was the result.
Mike has a 30 year mortgage on his house for $200K. He has paid it down to 20 years and 150K. During this time he gets laid off and is unable to continue payments in the full amount due. Neither the bank, nor Mike want a foreclosure.
Why doesn’t the bank offer to extend his mortgage to 30 years on 150K. His payments get substantially lower and the bank ends up raking in more interest.
At present, this is going on to some degree. A number of the announced loan modifications are structured in the manner you describe. The problem is that if Mike has no job, there’s no reason to believe that he can continue making the lower payments either. You either have to hope that the extra time the loan modification buys allows Mike to find a job, or else hope that housing market conditions improve in that time such that the house can be sold without suffering a big loss. Google “extend and pretend.”
In more normal economic times, there would be little incentive for the bank to do this. Usually, Mike would have equity in his home; i.e. the value of the home would be greater than the loan principal. So if Mike became delinquent on his loan, the bank wouldn’t have too much of an issue taking ownership of the home and selling it. But with housing prices falling back to historical norms, a number of homeowners have mortgages that now exceed the value of their home, a negative equity situation.
Reasons why not:
Mike is now a credit risk. The bank would rather deal with someone with reliable steady income. If his mortgage is past due, he’s a risky borrower. If his income is reduced, he may not be viable to repay the new loan.
Reason why to:
These would not have been considered prior to the real-estate bust.
The bank can’ t make its money back by foreclosing because the property isn’t worth 150k. (not likely if he’s had it for 10 years, but possible)
Mike’s 10 years of paying may mean something to a smaller bank.
The paperwork on refinancing is simpler/faster than foreclosure.
Even in today’s market the reasons why not equate to less of a gamble than the reasons why to. To a bank, 130k now for the foreclosed house is worth more than the potential for 250k over 30 years. Or maybe it’s not. It does depend on the bank. Some banks will favor the new loan, some will favor foreclosure and liquidation of the mortgage asset. A bank that is struggling will want the money now. A bank that is sound will be more willing to make the new loan - if Mike has a new reliable job.
The main reason for the bank not to give Mike another 30-year loan is that it would be, by definition, a subprime loan! And it’s exactly these types of loans that have contributed to the current financial crisis.