What is a Loan Modification

loan-modificationA loan modification is an agreement between a lender and a borrower to change the original terms of a loan in order to make a borrower’s payment more affordable. The lender(bank) is motivated to do this because the Federal Government has instituted the Home Affordable Modification Program (HAMP). This program gives mortgage companies financial incentives to modify existing first lien mortgages.

There are a few ways that a loan modification may be accomplished. A loan modification can consist of a reducing the interest rate, changing from a fully amortized loan to an Interest Only loan for 5 to 7 years, extending the loan term, reducing the principal balance of the loan (very rare), and resolving any overdue payments by adding them to the balance of the loan.

There are some negatives behind loan modifications:

  1. Even after your loan has been modified, you are still under all the same debt. Very rarely does the bank reduce the principal balance of your loan. They will simply extend the terms of the loan and/or reduce your interest rate. Short selling your home on the other hand will get you out from under the debt and in some cases let you purchase a new home the next day.
  2. Another negative of a loan modification is that to qualify the borrower generally needs to be behind or in default on their mortgage. The negative impact late mortgage payments have on one’s credit report are substantial – approximately -40 points per late payment!

Who Qualifies for a Loan Modification?

Not everyone can qualify for a loan modification.  There are a few criteria the bank will look at when a loan modification is requested.

  1. There generally must be a hardship.  Examples of a hardship are as follows: illness, death of a spouse or co-borrower, divorce, incarceration, reduced income, job relocation, medical bills, military duty, damage to property, or an adjustable mortgage reset. The borrower needs to document the hardship and provide a hardship letter to the lender.
  2. There is not enough equity reaming to sell the home and payoff the mortgage without the bank agreeing to take less than owed.
  3. The borrower needs to provide documentation that proves they can make the modified mortgage payments.

Since a loan modification is a negotiation and not a refinance, there are no set rules. Each borrower’s situation is different. One thing is certain, banks want to avoid foreclosure at all costs! Short selling and loan modifications are the best alternative to foreclosure!