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 two kinds of loan modifications typically offered, according to Charles Gallagher, an attorney and partner at St. Petersburg, Florida-based Gallagher & Associates Law Firm, P.A., which represented several clients in foreclosure who recently sued Caliber Home Loans over its loan modification practices.

  1. Streamline modification, “where the borrower does not provide financials to underwrite and the servicer or lender provides a modification with monthly payment terms,” Gallagher says.
  2. Standard modification, which “requires some underwriting on the part of the lender or servicer to test for repayment viability; this requires you to provide proof of income and related financial documents,” Gallagher says. 

“It’s essential to understand the terms of a loan modification, including what your new payments are going to be, if the changes are temporary or permanent and what the long-term implications are as far as overall loan cost,” Sharga says.

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, and it’s typically not done to avoid going into foreclosure, but rather to save you 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, Sharga says.

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. If you have a government-insured loan, the last day to request forbearance due to pandemic-related hardship is June 30, 2021. If your loan is backed by Fannie Mae or Freddie Mac, you can request forbearance at any time. 

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.

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