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Keepin' It Real Estate: Do Loan Modifications Work?

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Getting to the "bottom" of the housing mess.

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With millions of homeowners falling behind on their monthly payments, one in 6 underwater, and countless more struggling to keep up, politicians and banks alike are jumping on the loan modification bandwagon.

A modification -- or "mod," as it's known in the industry -- is simply the bank agreeing to change a borrower's loan to make it more affordable. Mods usually result in a lower interest rate, principal forgiveness or some combination thereof.

For banks, adjusting loan terms is a way to keep cash coming in the door - even if it's less than they'd been hoping for when they originally wrote the loan. For troubled borrowers, mods can provide an alternative to default and eventual foreclosure. It's for these reasons that FDIC Chairman Sheila Bair and big banks like JPMorgan (JPM) and Bank of America (BAC) are aggressively promoting mods as the best way to fix the housing market.

The flood of troubled mortgages has also fostered a cottage industry that caters to distressed borrowers. Some are honest folks aiming to help struggling borrowers by using their mortgage expertise and contacts to negotiate better deals on behalf of their clients.

Others, however, are less upstanding.

According to Mandana Nejad, a real estate attorney and founder of Silver Lining Legal Group, a loan modification firm based in California, troubled borrowers have a lot to be wary of.

"Most loan modification companies are compromised of former lenders and brokers who put homeowners in these horrible loans in the first place," says Nejad. "Meanwhile, credit repair and debt consolidation firms are simply out to collect fees, regardless of whether or not they can actually successfully modify a loan."

Last year, the Bush administration formed HOPE NOW, a government-led effort to get banks and the loan servicers who collect payments on their behalf to step up loan-modification efforts. By most accounts, results were underwhelming, as HOPE NOW counselors often asked for too much, and banks gave too little.

Data show that mods done at the outset of the mortgage crisis ended up in default, despite the lower payments. Without proper screening criteria, mods simply delay the inevitable.

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