What Is A Loan Modification?

A loan modification is a change to the original terms of your mortgage loan. Unlike a refinance, a loan modification doesn’t pay off your current mortgage and replace it with a new one. Instead, it directly changes the conditions of your loan.

 

It’s also important to know that modification programs may negatively impact your credit score. If you're current on your mortgage, it would be better to review your options and see if you can apply to refinance.

 

You can only get a loan modification through your current lender because they must approve the terms. Some of the things a modification may adjust include:

• Loan term changes: If you’re having trouble making your monthly payments, you may be able to modify your loan and extend your term. This gives you more time to repay your loan and reduces the amount you must pay every month.

 

• Interest rate reduction: If interest rates are lower now than when you locked into your mortgage loan, you might be able to modify your loan and get a lower rate. This usually lowers your monthly payment.

 

• Loan structure changes: You may be able to modify your loan from an adjustable interest structure to a fixed-rate loan. This can be beneficial if you now live on a fixed income and you need a more predictable monthly payment.

 

• Principal forbearance: Your lender may agree to set some of your principal balance aside to be paid back later. This can help reduce payments and/or make your mortgage more manageable. However, these modifications are rare. You can usually only get a principal forbearance if no other possible solution will help you avoid foreclosure. You usually also have to subscribe to a repayment plan to qualify for a principal forbearance. A repayment plan allows your lender to see if you can stay on top of your new payments. Your lender may agree to settle some of your principal after you complete the repayment plan trial period.

 

Lenders have no obligation to accept your request for a modification or to renegotiate your principal. This means that getting a modification is usually more difficult than refinancing. You'll need to show evidence of hardship. Every lender and investor in the loan (such as Fannie Mae, Freddie Mac, FHA, etc.) has their own standards when it comes to who qualifies for a modification and what types of modifications they offer.

 

You may receive offers from settlement companies to help you get a loan modification if you’re behind on your mortgage. These companies negotiate with your lender on your behalf and can make getting a loan modification easier. However, it's important to note that these companies often serve as middlemen, charging you for a service that your loan servicer will provide for free.

 

If you do decide to work with one of these companies, do your research on the provider before you agree to any contract. The last thing you need is a high-fee contract with a settlement company if you’re already behind on your mortgage payments. If what's being offered seems too good to be true, chances are it probably is.

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When Should You Use A Loan Modification?

It makes sense to seek a loan modification before a refinance in some instances. Let’s take a look at some of those times.

 

• Your loan is underwater. An underwater mortgage is when you owe more money on your home than your property will appraise for. Your loan can go underwater if you miss payments early in your term or you live in an area where property values are falling. Most lenders won’t allow you to refinance more than your home is worth. Though there are streamline options that can allow you to change your rate and term without an appraisal, you must meet specific criteria to qualify for each option. Ask your lender for a direct modification to simplify the process and help you when you’re underwater.

 

• You need a principal reduction. You cannot reduce your mortgage principal with a refinance. A loan modification may be able to help if you’re likely to go into foreclosure.

 

• You’re behind on your monthly payments. A lender won’t allow you to refinance unless you’re current on your monthly payments. Some types of refinances for underwater loans require that you have at least six consecutive on-time payments to qualify. Seek a modification if you can’t catch up on your monthly payments before you apply.

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How To Modify Your Loan

Every loan servicer has their own standards for loan modification. Most require you to apply with financial documentation that proves you need the modification. Some of these documents include:

 

• Proof of income: Your lender needs to know that you don’t have enough income to cover your current mortgage. Proof of income can include a salary agreement or contract from your employer that states your hourly rate or annual income. Your lender might ask for a profit and loss balance if you’re self-employed.

 

• Your most recent tax return: Your lender will likely need your entire tax return when you request a modification.

 

• Bank statements: Your lender might ask for bank statements to confirm your assets.

 

• A hardship statement: Your lender needs to know why you want a modification. Your hardship letter tells your lender why you can no longer make your monthly payments or pay for your entire loan balance. You may also want to include supplementary documentation along with your letter to further illustrate your situation. Things like medical bills or a termination letter from your previous employer can increase your chances of approval.

 

Contact your lender and ask how to apply if you think you qualify for a modification. Keep in mind that your lender may refuse your request. You may still qualify for a refinance if that happens to you.