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. 

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 is 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.”

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.

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, and/or reducing the interest rate.

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, and 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, asking for 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 or VA 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.

What to look for in a loan modification

If you’re having trouble paying your mortgage, especially now, request forbearance from your servicer or lender if you haven’t already. Borrowers with COVID-19-related forbearance plans might be able to get the relief extended up to 18 months, depending their loan.

If you’re considering asking for a modification instead, the terms will be up to you and the lender. Avoid short-term solutions that’ll just leave you with a larger hole to climb out of.

“Any loan modification that bests the terms of your original loan and keeps you in your home is generally a win,” Gallagher says. “If the modification discounts the existing interest rate, lowers the monthly payment, waives missed payments and late fees or discharges principal, that’s favorable to the borrower.”

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.

“To be safe, have an attorney or credit counselor review your loan modification documents before you sign them,” adds Sharga.

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.

With additional reporting by TJ Porter

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