More on Loan Modification

Calculated Risk: IndyMac Mods: Principal Forbearance Vs. Reduction

First, the interest rate is lowered to the current Freddie Mac survey rate for fixed rate mortgages, and fully amortized as a fixed rate loan. As far as I can tell, at this initial step, the loan is amortized over its remaining term, whatever that is.

If that is not enough to achieve 38% HTI, then the interest rate is "stepped" for up to five years. That means that the initial rate is set no lower than 3.00% for the first year, and increased each year by no more than 1.00% per year, until it hits the Freddie Mac survey rate (which was 6.50% at the time FDIC published). This does not make the loan an ARM or subject it to negative amortization; the payment is re-amortized each year after the interest rate "steps up" until it hits the permanent rate. That means that the loan is always paying some principal from the inception of the mod.

Remember that ARMs involve potential rate increases; whether they happen or not, and how far they go, depend on future (unknown) movements in the underlying index. A "step loan," which is what I understand these mods to be, has scheduled rate increases that are exactly specified in the modification agreement, and which are not subject to future market rate fluctuations: each loan will "step up" to the permanent rate, regardless of what happens in a year or four to market interest rates. So the borrower gets the same kind of long-term "rate lock" of a fixed rate loan--the rate will never be higher than 6.50% (or whatever the Freddie rate is on the day the mod is drawn up), and after the initial "step" period it will never be lower than that. The step period simply "ramps" the borrower into the fully-amortized payment at 6.50% by starting out with a fully-amortized payment at a lower rate and slowly increasing that rate each year until the final rate is achieved.