Principal Reduction

Often used as a way to restructure debt, a decrease in principle can improve and restore asset liquidity. As a device to alleviate the home mortgage crisis, the concept of Principal Reduction has produced a number of programs encouraged by the US government and carried out by banking institutions holding distressed properties. The motivation a bank has to participate in one or more of these programs is the repercussions of alternative actions up to (and including) foreclosure on a property. On average, the combined costs associated with foreclosure and the lower property value have yielded between 50% to 70% of the principal balance of the loan for the institution holding the mortgage. If possible, a mortgage company can adjust the payments on a house by reducing the principal and adjusting interest rates and thereby keep the homeowner in the residence while meeting the adjusted obligations, it may be advantageous to the financial institution, the homeowner and the community. A common criterion for the homeowner is to achieve parity between the adjusted principal balance on the loan and the value of the property as determined by recent comparable sales. The criterion for the institution is to reduce the principal balance enough to reach principal balance and value parity without loosing more money than the foreclosure process would generate. Although the holder of the mortgage could not sell the property for more than the current market value, financial institutions have developed other programs to hold the property and strategically release listings in a manner that stabilizes property values. This creates a shadow market that is hard to measure with publicly available information.