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 mortgage 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. It likely won’t reduce the amount you owe on the balance of your mortgage.

Lenders allow borrowers to modify loans because 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. A modification helps accomplish both goals.

“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 a mortgage modification can affect your loan

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).

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.  Compare the total payments under your original loan to the total payments under the modified loan. What you don’t want is a temporary reduction only to find the reduced amount added back on to your mortgage balance and then have to pay interest on the larger balance.

Also, 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. These types of modifications might only make sense if you plan to hang onto the home just long enough to sell it, in order to salvage your equity and credit.

Example of a mortgage modification

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. However, they will now be paying interest for an additional five years.

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 the pandemic, FHA loan borrowers also have the option to obtain a lower rate and have their monthly payments cut by at least 25 percent. If it’s not possible to cut payments by that much with a standard 30-year loan, FHA borrowers now have the option to extend the loan term up to 40 years, as well.
  • 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.   All these programs in the end increase the loan balance due and the total interest paid.  If you have a permanent loss of income your best bet might be just selling and moving to a less expensive home or renting.

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  don’t kid  yourself about being 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. Keep in mind, refinancing only works if current interest rates are significantly lower than the rate on your existing 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 (which will cost you in interest). Forbearance is the best option in situations that are truly temporary, such as a short-term accident or illness that you know you’ll recover from, and continue working at the same capacity afterward.

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. Get the forbearance agreement in writing signed by the lender.

How to apply for 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. This letter should be clear, accurate, complete and business-like. Keep emotions out of it.

2. Plan out your case

Before contacting your lender or servicer, be honest with yourself and 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. Keep records of your correspondence and actions along with any supporting evidence.

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.

Mortgage modification FAQ

  • Unless your lender reports your mortgage “paid as agreed,” a loan modification can hurt your credit score. “Loan modification can affect your credit score, but it depends on how the servicer — the company that collects your mortgage payments — reports it to the credit bureaus,” says Matt Hackett, operations manager for Equity Now, a mortgage lender headquartered in Mamaroneck, New York. “It is worth asking your servicer this question when you are pursuing a loan modification.”
  • Modifying your mortgage simply revises the terms of your mortgage contract. It doesn’t impact your ability to refinance a mortgage in the future. “You can refinance after a loan modification and the guidelines vary across the different loan types,” says Hackett. “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.”
  • Depending on the type of modification you pursue, it can end up resulting in more interest. “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 Churchill 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.”
  • Mortgage loan modification scams are 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 and do not proceed. Remember: If it sounds too good to be true, it is too good to be true.