Does A Loan Modification Hurt Your Credit? What You Need To Know

A loan modification can be a lifeline for borrowers struggling to make their mortgage payments. By extending the repayment term lowering the interest rate or reducing the principal balance a modification makes monthly payments more affordable. But will the process hurt your credit? Let’s take a close look at how loan modifications can impact your credit score.

The Short-Term Credit Score Hit

There’s no doubt that a loan modification can damage your credit, at least temporarily. Here are some of the ways it can bring your scores down

• Missed payments – Most lenders will only approve a modification after you’ve missed at least one payment. A single 30-day late mortgage payment can knock 50-100 points off your credit scores.

• Settlement reporting – The lender may report the modified loan to the credit bureaus as a settlement, which indicates you did not fulfill the original terms. This can hurt your scores significantly.

• Lower credit limits – As part of the modification, the lender may lower your credit limit. This increases your credit utilization ratio and lowers your scores.

• New credit inquiries – Applying for a modification requires the lender to pull your credit report, creating a new inquiry. Too many inquiries in a short period can lower your scores.

So in the short run, expect your credit scores to take an initial dip, potentially by 100 points or more depending on your situation. But take heart – the damage isn’t permanent, and the long-term impact may actually be positive.

Long-Term Benefits for Your Credit

Although it hurts at first, a loan modification can help your credit in the long run in a few key ways:

• Prevents foreclosure – Foreclosure is devastating to your credit, damaging your scores for years. A modification helps you avoid this fate.

• Shows you can manage debt – Making reduced payments on time demonstrates responsibility, boosting your scores over time.

• Negative marks eventually fall off – Derogatory marks from the modification stay on your reports for 7 years, but their sting fades.

• Shows positive payment history – Once the modification takes effect, on-time payments will be reported. This builds your scores back up.

• Lowers credit utilization – With reduced monthly payments, your credit usage ratio will decrease, helping your scores.

So if you stay current on the modified mortgage, the impact on your credit tends to improve after about a year. Within 2-3 years, your scores can fully recover and may even exceed the pre-modification level.

Tips to Minimize the Credit Damage

If you’re pursuing a mortgage modification, there are a few strategies that can help minimize damage to your credit:

• Ask how it will be reported – Find out if the lender will report it as a settlement. If so, negotiate to have it reported as “paid as agreed” instead.

• Get everything in writing – Have the lender provide written documentation that they will report the modification positively.

• Don’t miss more payments – Your scores take a massive hit with each late payment, so stay current during the process.

• Pay down credit cards – Reduce your overall utilization by paying down revolving debt while going through the modification.

• Monitor your credit – Check your credit reports regularly so you can dispute any errors.

• Build positive credit – After modification, focus on responsible credit management to rebuild your scores.

When Is Modification the Right Move?

Here are some signs that a mortgage modification may be your best option:

• You’ve experienced a financial hardship like job loss, reduced income, or high medical bills. The modification can provide temporary relief.

• You have an adjustable-rate mortgage and can’t afford payments at the reset rate. Modification can make it fixed rate.

• Your mortgage balance far exceeds the home’s value. Principal reduction can get you above water.

• Loan terms were initially unfavorable. Refinancing isn’t an option, but modification can improve terms.

• You have excessive housing expenses. Modification allows you to avoid having to sell or foreclose.

Even with the credit score impact, a modification can be the lifeline you need to hold onto your home in times of financial stress. If you stay committed to the new loan terms, your credit can fully recover within a few years. Just be sure to consult your lender to understand all the implications before moving forward. With patience and diligence, modified financing can put you back on solid ground.