As a Northern Virginia short sale listing agent, I meet many sellers who really seem confused on what happens in a loan modification. There seems to be a general misconception that loan modification means a portion of your principal loan balance will be forgiven and reflect more of the market value of your home. While this may happen in RARE instances, it is not how mortgage lenders will do business 99.9% of the time.
Loan modification is actually a temporary reduction in interest rate to help you through a financial rough patch. When you signed your loan documents, you promised to repay the amount of money you borrowed. Why would the bank modify that? It is the amount you borrowed. What banks can do is adjust the interest on your loan, but only temporarily, usually for one year.
If you need a longer term adjustment of interest rate, you may want to look into a refinance. Under new guidelines, you may be able to refinance up to 105% of the value of your home. Until you talk to you mortgage lender, you won't know exactly what your options are.
When you are facing difficulty paying your mortgage, the first step is talking to you mortgage holder to see what modification they may be able to perform on your mortgage. Just make sure you go into that conversation with realistic expectations.