What Is Mortgage Loan Modification? How To Get One

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What is a loan modification?

A mortgage loan modification is a relief option designed for borrowers experiencing long-term financial hardships that make it impossible for them to keep up with payments. The goal is to reduce your monthly payments to an affordable level, helping you stay up to date on the loan — and in your home.

The modification permanently changes your existing mortgage. If approved by your lender, it can lower your interest rate, change the structure of your overall loan or both.

Lenders allow loan modification agreements because the alternative — default and foreclosure — are more costly to their business. In other words, they don’t want the house, but they do want the loan repaid, and a modification helps them accomplish both goals.

Who qualifies for a loan modification?

You can’t just get your loan modified because you want to save some money. A mortgage loan modification is a solution for borrowers facing significant financial hardship.

In order to qualify for a mortgage modification, you’ll typically need to meet these three minimum requirements:

1. Provide proof of significant financial hardship that impedes your ability to pay back the loan as it currently exists. Examples can include a long-term illness or disability, the death of an income-providing family member, a sudden hike in housing costs (like property taxes), divorce or a natural disaster.
2. Be at least one month behind on your loan or about to miss a payment.
3. Live in the home as your primary residence.

Before approving your loan modification, many servicers will require you to successfully complete a trial period plan. For this period, which typically lasts three or four months, you’ll make payments of the proposed modified amount. If you make them all on time, the modification will likely be finalized.

Types of mortgage modifications

There are several ways to make your mortgage more affordable, and your options could differ based on the type of loan you have.

In general, your lender or servicer might implement one or more of these modification options:

• Cut the interest rate: With a lower rate, you’ll have lower monthly mortgage payments and save on interest in the long run.
• Extend the repayment period: Lengthening the loan term also lowers your monthly mortgage payments.
• Reduce the principal: In some cases, the lender might forgive some of the loan balance to lower your monthly payments. Keep in mind, though, that the IRS treats forgiven debt as income, so you’ll need to report it on your tax return.
• Convert an adjustable rate to a fixed rate: The interest rate on an adjustable-rate mortgage fluctuates. If it goes up, your monthly payments might no longer fit into your budget. Swapping to a fixed-rate mortgage gives you more financial stability.

Keep in mind that some modifications might save you money in the short term, but not necessarily in the long term. “If the modification means extending the term of the loan — which is often the case — you will pay more interest,” says Seth Bellas, a producing branch manager for Canopy Mortgage in Michigan. “A common modification is taking the amortization of the loan from 30 years to 40 years, which would mean you are paying the principal at a slower rate, and thus paying more interest.”

However, if the modification helps you stay in your home, you might not mind that trade-off.

Mortgage modification programs

There are different modification programs for different types of loans:

• Conventional loans: If you have a conventional mortgage backed by Fannie Mae or Freddie Mac, you might be eligible for the Flex Modification program, which can reduce your monthly payments by up to 20%, extend the loan term up to 40 years and potentially lower the interest rate.
• FHA loans: FHA loan modification options include an interest-free loan for up to 30% of your balance or a 40-year loan extension.
• VA loans: If you have a VA loan, you might be able to roll the missed payments back into the loan balance and work with your lender to come up with a new, more manageable repayment schedule. You can also request a 40-year extension to your loan term.
• USDA loans: With a USDA loan, you can modify your mortgage with an extended term of up to 40 years, reduce the interest rate and receive a “mortgage recovery advance,” a one-time payment to bring the loan current.

How to apply for a loan modification

If you need a mortgage loan modification, follow these steps to apply for one with your servicer:

1. Review your circumstances: Before contacting your loan servicer, consider whether the hardship requires a long- or short-term solution. If you foresee being able to repay your current mortgage in the future, your servicer might offer you another relief option instead.

2. Organize documentation proving financial hardship: In addition to providing your servicer with bank and other financial statements to show reduced income, put together a letter explaining the circumstances of the hardship.

3. Contact your servicer: Contact your servicer’s loss mitigation department and ask for a loan modification. Keep a careful record of the representatives you interact with, and get everything in writing. If your request is denied, you might be able to ask for a second review if you applied at least three months before your home’s foreclosure sale.

4. Review the terms carefully: If your request is approved, compare the total payments under your original loan to the total payments under the mortgage modification. You’ll want to avoid a temporary reduction, with the reduced amount added back onto your balance later. In addition, avoid any modifications that are interest-only and adjust to a higher rate or add costs in the form of penalties, fees or processing charges, says Rick Sharga of CJ Patrick Company, a California-based real estate consulting firm.

5. Keep track of your new payments. Make sure you understand the new monthly payment, when it’s due and any long-term implications for your finances.

Alternatives

A mortgage modification may not always be the best solution. If you are facing financial hardship, consider these alternative options as well:

• Forbearance: Mortgage forbearance is a short-term solution in which the lender agrees to suspend or reduce your monthly payments for up to one year. Interest will continue to accrue during this period. Once the forbearance ends, you’ll be put on a repayment plan.
• Refinance: You might consider refinancing if interest rates have fallen since you got your loan. Refinancing can help you lower your monthly payment permanently, either by reducing the loan’s rate or extending its repayment term. However, if you’re at the point of considering a modification, you likely won’t have the income to qualify — or the savings to pay for closing costs.
• Short sale: Short sales involve selling your home when the balance of your mortgage is more than the home’s value (often called being “underwater”). Your lender will need to approve this type of sale, and it can have tax implications.
• Deed in lieu of foreclosure: This is a last-resort option where you give up the deed to your home in exchange for the lender releasing you from the loan payments. This allows you to avoid the severe credit damage of a foreclosure, but still means you lose the home.

FAQs

• Does a loan modification affect my credit score?
  

  Yes, a loan modification can hurt your credit score unless your lender reports your mortgage “paid as agreed” to the credit bureaus. Make sure to ask your servicer about this when looking into a loan modification so you know what to expect.

• Can you refinance after doing a loan modification?
  

  Yes, it’s possible to refinance after a loan modification — but you may have to meet certain requirements. “The guidelines vary across the different loan types,” says Matt Hackett, SVP and head of operations for Equity Now, a Dallas-based mortgage servicer. “In some instances, a lender may look for 12 months of on-time payments after a modification before you can refinance. This varies, however, and is also based on whether you were paying on time before the modification.”

• What are loan modification scams?
  

  Unfortunately, there are mortgage loan modification scams out there designed to take your money with the false promise of preventing foreclosure. “Scam artists offer to act as an intermediary between the homeowner and the lender,” says Bellas. “Some of the tactics they use include asking you to sign your title over to them, or telling you to stop making payments to your current lender.” A scammer might also request money upfront or encourage you to sign paperwork that is intentionally confusing. If you are asked to do any of these things, consider it a red flag.