For the record, mortgage lenders aren’t required by law to cut mortgage principals as part of loan modification deals. Principal reductions are only one item on the government loan modification menu, along with extending the term of the loan and lowering the loan interest rate.
But data is beginning to emerge that suggests banks make out better in the long run if they take a paring knife, but not a meat cleaver, to loan principal amounts.
One big reason is a psychological one. Homeowners who are underwater on their mortgage don’t have the incentive to make good on their loan obligation if the value of their loan exceeds their home’s value.
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