Is a Loan Modification a Good Idea for Struggling Homeowners?
Falling behind on your mortgage payments can be scary. You may be worried about losing your home to foreclosure. But you have options to avoid this worst-case scenario. A loan modification could help you get your finances back on track.
A loan modification is when your mortgage lender or servicer agrees to change the terms of your existing home loan This is done to make your monthly payments more affordable during a period of financial hardship
Modifications are a last resort for borrowers who can’t qualify to refinance their mortgage. But is loan modification a smart move? Or are there better alternatives?
In this article. we’ll explain
- What is mortgage loan modification?
- When loan modification makes sense
- The pros and cons of modifying your home loan
- How to apply for a loan modification
- Alternatives like mortgage refinancing
Let’s start with the basics of what loan modification entails.
What Is Mortgage Loan Modification?
A mortgage loan modification allows you to restructure your existing home loan. Your lender or servicer may agree to one or more of the following changes:
- Lower your interest rate – This reduces your monthly principal and interest payments
- Extend your repayment term – Stretching out your loan over more years means lower monthly payments
- Add missed payments to your balance – Delinquent amounts get rolled into your overall loan balance
The goal is to reduce your ongoing monthly mortgage payment. This makes it more affordable so you can avoid defaulting on your home loan obligations.
Loan modifications do not require refinancing or origining a new mortgage. You keep your current lender and loan. The terms are simply adjusted to create a payment you can manage.
Mortgage lenders are not obligated to modify your loan. You must prove financial hardship and qualify based on their specific eligibility guidelines.
When Is Mortgage Loan Modification a Good Idea?
Struggling homeowners may consider loan modification if:
- Your income has decreased substantially
- You’ve racked up high medical bills or other unexpected debts
- Your mortgage payment became unaffordable due to interest rate adjustments
- You’ve exhausted options like forbearance and need permanent payment relief
You’ll usually need to be at least 90 days behind on your mortgage to qualify for modification. This shows the lender you’re unable to afford your current loan terms.
Homeowners who are still current on payments can sometimes get “imminent default” status. This means the servicer agrees you’re headed for default very soon without assistance. But you’ll need strong evidence of financial hardship.
Either way, loan modification provides a last chance to save your home when your finances take a major hit. It can help you stabilize your budget and avoid foreclosure.
The Pros of Mortgage Loan Modification
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Allows you to keep your home – Modification helps prevent foreclosure, allowing homeowners to stay in their house.
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No loan origination costs – Unlike refinancing, modification has no upfront closing costs.
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May improve cash flow – Lowering your monthly payments can free up cash that’s desperately needed.
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Doesn’t require credit approval – Lenders consider your ability to repay the modified loan, not your credit scores.
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Permanent solution – Once approved, the modified loan terms are in effect for the remainder of your loan.
The Cons of Mortgage Loan Modification
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Extends loan term – Adding missed payments to your balance makes your loan take longer to pay off, costing more interest.
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Credit damage – Being 90+ days delinquent severely hurts your credit. Modification alone won’t remove these late payments from your credit history.
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No interest rate reduction – Your rate may stay the same or even increase with certain types of modifications.
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Home value matters – If your loan balance grows higher than your home’s market value, it becomes harder to sell or refinance later.
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Limited to your current lender – You can’t shop around to see if another lender could offer better mortgage relief options.
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Equity stake possible – In rare cases, your lender may request partial ownership in your home in return for modifying your loan.
Clearly, loan modification has pros and cons to weigh. It’s very situational. For some borrowers, it can be a financial lifesaver.
How to Apply for Loan Modification
If you think you may qualify for mortgage modification, here are the steps to take:
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Contact your loan servicer – This is the company you make mortgage payments to. Explain your financial hardship and inability to pay.
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Send a hardship letter – Detail the circumstances that caused you to fall behind and request loan modification options.
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Gather documentation – Expect to provide income statements, tax returns, bank statements, hardship evidence, and other financial docs.
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Complete trial period – You’ll need to make three on-time trial payments in the modified amount before your modification is finalized.
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Get final approval – After successfully completing the trial period, sign the official loan modification agreement.
This process takes 30-90 days on average. You’ll need to stay in close communication with your mortgage servicer throughout.
Be aware the lender may charge an application or processing fee of around $500-$1,500 for doing a loan modification.
Alternatives to Mortgage Loan Modification
Before pursuing modification, consider two alternatives:
Mortgage Refinancing
Ideally, refinancing to a new home loan with better terms is the best option. You can potentially get a lower rate and payment without the downsides of modification.
Refinancing can be challenging if your income or credit scores have dropped. But programs like FHA Streamline Refi and VA IRRRL loans help credit-challenged borrowers.
Explore refinancing as your first choice, if possible. This lets you shop lenders to find the best possible loan terms.
Loan Forbearance
Ask your servicer about a forbearance plan to temporarily pause or reduce mortgage payments for several months. This provides short-term relief while you work on improving your financial situation.
Once your forbearance period ends, you can resume normal payments or pursue loan modification for ongoing assistance.
There’s no one-size-fits-all answer on loan modifications. The pros and cons will depend on your specific situation.
In general, modification does make sense for borrowers who:
- Have experienced long-term loss of income
- Don’t expect their financial hardship to improve in the near future
- Have already missed several mortgage payments
- Have no other options to avoid foreclosure
Just be sure modification aligns with your long-term financial goals. Will the change in loan terms make it harder to build equity and wealth through your home in the future?
Consult with housing counselors and legal advisors to understand all your alternatives. An informed decision will lead to the optimal outcome.
Above all, be proactive if you anticipate struggling with mortgage payments. Take action before you miss payments to maximize solutions. Both loan modification and refinancing become more difficult the further behind you fall.
Who is eligible for a loan modification?
To qualify for a loan modification, a borrower usually must have missed at least three mortgage payments and be in default.
“Sometimes, a borrower who has experienced financial setbacks, which makes a default imminent, can qualify for a loan modification. But not everyone in default under their mortgage is eligible for a loan modification,” says Elizabeth Whitman, attorney and managing member of Whitman Legal Solutions, LLC.
“Borrowers whose financial setback is so severe that they will never be able to repay their mortgage won’t receive a modification, nor will borrowers who have the ability to make mortgage payments either from their income or savings.”
In addition to providing a hardship letter or statement to your current lender, prepare to provide proof of income, two years’ worth of tax returns, bank statements, and other financial statements, says Condor.
Be aware, however, that your mortgage lender is not obligated to provide a loan modification.
“Once a lender has an executed contract — meaning the home loan — they don’t have to change it. Many [homeowners] are denied a mortgage loan modification,” Gallagher explains.
“If the lender desires to modify the terms, per your request, then you have a starting point.”
Is mortgage loan modification a good idea?
A mortgage loan modification is worth pursuing for the right candidates.
“A modification can give you a second bite at the apple and get you out of the default or foreclosure process, allowing you a chance to remain in your home,” says Merritt.
“Typically, a modification will take all of your missed payments and add those to the outstanding principal balance,” Merritt says.
Say your current mortgage has an outstanding balance of $300,000. Assume you missed $50,000 in payments. In this example, your modified balance would be $350,000, which is called “capitalization.”
“But imagine your home’s value is only $310,000,” adds Merritt. “Here, a modification would allow you to stay in your home and avoid foreclosure, but you would owe more than your house is worth. That would be a problem if, say, two years after modification you wanted to sell your home.”
4 Pros and 3 Cons of a Loan Modification
FAQ
What is the disadvantage of loan modification?
Is loan modification bad for your credit?
Is a loan modification worth it?
How much will a loan modification reduce my payment?
What is a home loan modification?
A home loan or mortgage modification is a relief plan for homeowners who are having difficulty affording their mortgage payments. Borrowers who qualify for loan modifications often have missed monthly mortgage payments or are at risk of missing a payment. Here’s what you need to know to get a mortgage loan modification and stay in your home.
Can you get a loan modification if you have a mortgage?
If you have a mortgage, you may be eligible for a loan modification. This can help make it easier to stay on top of mortgage payments and avoid foreclosure. What is a loan modification? A loan modification is a way to change the terms of your mortgage, making it more manageable for you. It is different from refinancing your mortgage.
Can a loan modification lower your monthly mortgage payment?
Though the terms of a loan modification are up to the lender, the outcome is lower, more affordable monthly mortgage payments. Foreclosure is a costly process for lenders, so many are willing to consider loan modification as a way to avoid it. » MORE: How to lower your monthly mortgage payment Who qualifies for a loan modification?
Will a loan modification affect my credit?
A loan modification changes the terms of your mortgage to make it more affordable, but it could affect your credit and the amount of interest you’ll pay.