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How to choose the right mortgage modification strategy

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Loan modifications are a long-term financial relief option for homeowners who can’t make their mortgage payments. If approved by your lender, this option can help you avoid foreclosure by lowering your interest rate or changing the structure of your overall loan.

Key takeaways
  • Loan modifications are a long-term mortgage relief option for borrowers experiencing financial hardship, such as loss of income due to illness.
  • A modification typically changes the loan’s rate or term (or both) to make monthly payments more affordable.
  • Borrowers seeking a modification have to provide proof of hardship to their mortgage lender or servicer.
  • Unlike forbearance, loan modifications are a permanent solution.
  • While refinancing can also help make monthly payments more manageable, a loan modification might be the only option for some borrowers.

What is a loan modification?

A loan modification involves changing your existing mortgage so it’s easier for you to keep up with your payments. These changes can include a new interest rate or a different repayment schedule. 

Lenders allow borrowers to modify loans because default and foreclosure are more costly to their business. 

“A loan modification entails changes made to the terms of the loan itself — usually reducing the interest rate or extending the length of the loan,” explains Rick Sharga, president and CEO of CJ Patrick Company, a real estate consulting firm in Trabuco Canyon, California. “This allows you to lower your monthly mortgage payment and, ultimately, prevent default and foreclosure.”

How loan modification works

There are different loan modification options depending on the type of mortgage. These might include reduced interest, a term extension, switching from an adjustable-rate mortgage to a fixed-rate mortgage or setting aside a portion of the principal to be paid back at a later date (or a combination). Here’s an example:

Jose and Fred obtained a 30-year mortgage for $200,000 at 4.19 percent interest. Seven years later, Fred suffered a workplace injury and is limited to part-time, remote work. Due to the reduction in household income, Jose and Fred can’t keep up with their current monthly mortgage payment of $976. Their mortgage lender offered a modification that extended the loan term on their balance of $172,577 for another five years. This bumped down their monthly payments to a more manageable $873.

Types of loan modifications

There are typically two kinds of loan modifications:

  • Streamline modification, which does not require the borrower to provide documentation of financials like assets, debts and income
  • Standard modification, which does require the borrower to provide financial information that the mortgage lender or servicer evaluates in underwriting

When obtaining a loan modification, confirm with your lender or servicer whether the modification is temporary or permanent, and what your new monthly payment will be. Always read the fine print, and ask questions if you’re unsure about the long-term implications of a modification. Avoid any modifications that are interest-only and adjust to a higher rate, add unnecessary costs to your loan in the form of penalties, fees or processing charges or result in a large balloon payment due after a certain period, Sharga recommends.

Loan modification programs

  • Conventional loan modification – For conventional mortgages, borrowers have the option to pursue the Flex Modification program, which can reduce monthly payments by up to 20 percent, extend the loan term up to 40 years and potentially lower the interest rate.
  • FHA loan modification – There are several modification strategies for borrowers with an FHA loan, including the option to reduce payments with an interest-free loan for up to 30 percent of the borrower’s balance. In this case, the borrower only makes payments on the remaining portion, then repays the interest-free loan when the home is sold or the borrower refinances. In light of COVID-19, there’s also the option for FHA loan borrowers to have their monthly payments cut by at least 25 percent, along with obtain a lower rate.
  • VA loan modification – Borrowers with a VA loan can roll the missed payments back into the loan balance and work with their lender to come up with a new, more manageable repayment schedule. Another option might be extending the loan term.
  • USDA loan modification – For borrowers with loans backed by the U.S. Department of Agriculture, options include modifying the mortgage with an extended term of up to 40 years, reducing the interest rate and receiving a “mortgage recovery advance,” a one-time payment to bring the loan current.

When should you use a loan modification?

If you’re having trouble making payments on your mortgage, a loan modification can be one way of obtaining relief. You might be struggling with payments if you lost a job and your new one pays less, for example, or if you’re dealing with an illness or other long-term hardship. With financial straits like these, it also might be challenging or impossible to refinance your mortgage, a loan modification might be the only solution to avoid foreclosure.

If you are able to refinance, however, that’s usually the better option. Likewise, if your financial struggles are temporary, forbearance (a short-term pause in payments) can be the better route to take.

Loan modification vs. refinance

With a loan modification, your lender or servicer changes the terms of your loan with the goal of preventing default and foreclosure. While you can also change the terms of your loan by refinancing, in a refinance situation, you can shop around with multiple lenders for a new loan. Typically, borrowers don’t refinance to avoid going into foreclosure, but rather to save money or take cash out.

Loan modification vs. forbearance

A loan modification is different from forbearance. Usually, forbearance is temporary and intended to help a borrower get through a short-term financial challenge.

With loan modifications, the modification type, term and details can vary from servicer to servicer and might fall under guidelines established by the Federal Housing Finance Agency (FHFA); the FHA, VA or USDA for government-backed loans; or by contractual terms for private lender-owned loans or loans in mortgage-backed securities. Each state could also have particular requirements for loan modifications.

By contrast, a forbearance permits you to skip monthly payments completely for a predetermined period agreed to by the lender. These deferred payments might be due in one lump sum after the forbearance period, or rolled into your remaining loan balance.

Another point of differentiation: A loan modification can hurt your credit score unless your lender reports it as “paid as agreed.” A forbearance, on the other hand, doesn’t impact your score because your lender continues to report your payments as up-to-date. To prevent any damage to your score, though, make sure you understand the terms of your forbearance period and when exactly you can temporarily stop making payments.

How to get a loan modification

1. Gather information about your financial situation 

You’ll need to give your lender or servicer everything from tax returns to pay stubs to demonstrate you’re experiencing financial hardship and are unable to make your monthly mortgage payments. You’ll also need to provide a letter explaining your situation. 

2. Plan out your case

Before contacting your lender or servicer, consider whether your circumstances require a long-term or short-term solution. Be prepared to make your case.

3. Contact your servicer

Contact your lender or servicer and ask for a loan modification. If you’re denied, you have 14 days after the denial date to ask for a review of your application, but only if you applied for the modification at least three months before the foreclosure sale of your home.

Is a loan modification right for me? 

A mortgage loan modification is a solution for borrowers facing long-term financial hardship, and it can offer permanent relief. If you’re struggling to make your mortgage payments, work with your lender or servicer to see if a loan modification is the best strategy for you. If you don’t foresee changes to your financial situation, it might be preferable to shorter-term fixes that could leave you with a larger hole to climb out of.

With additional reporting by TJ Porter

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Written by
Erik J. Martin
Contributing writer
Erik J. Martin is a Chicago area-based freelance writer/editor whose articles have been featured in AARP The Magazine, Reader's Digest, The Costco Connection, The Motley Fool and other publications. He often writes on topics related to real estate, business, technology, health care, insurance and entertainment.
Edited by
Mortgage editor
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Part of  Guide to Mortgage Relief