Everything You Need To Know About Loan Modifications

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If you’ve recently fallen behind on monthly mortgage payments, you could be at risk of losing your home. But you might also be eligible for a mortgage loan modification, which can help you get back on track and avoid foreclosure. Not everyone struggling to make payments can receive a loan modification, so it pays to find out if you qualify.

Here’s what you need to know about loan modifications:

• What is a loan modification?
• Qualifying for a mortgage loan modification
• How loan modifications work
• How to get a loan modification
• Alternatives to mortgage loan modification

What is a loan modification?

A loan modification is an agreement between you and your lender that permanently changes your home loan terms. The goal is to make your payments more affordable, creating a win-win situation: You have a better shot at keeping your home, while the lender doesn’t have to handle an expensive and time-consuming foreclosure proceeding.

The lender might agree to:

• Extend the number of years to repay the mortgage
• Reduce your interest rate
• Reduce your principal balance

If your lender offers you a mortgage modification, ask how it will change your monthly payments, and calculate the interest you pay in the long term.

A loan modification could impact a homeowner’s credit, but less than a foreclosure would.

Read On: What to Do If You Fall Behind on Mortgage Payments

Qualifying for a mortgage loan modification

Loan modifications are only extended to borrowers in financial crises and who are in danger of defaulting on their original loans.

Lenders can set their own criteria for eligibility, but the requirements are usually that:

• You’ve missed at least one payment
• You can provide proof of financial hardship
• You have evidence that you could make your payments with a modified loan

These are typically negotiated through a lawyer or a settlement company.

Qualifying for a government loan modification program

Fannie Mae and Freddie Mac, two government-sponsored agencies that back most of America’s conventional loans, offer a Flex Modification program for eligible borrowers. Generally, the program aims to reduce your monthly mortgage payment by 20%.

Here’s the criteria to be approved for this type of mortgage modification:

• You have a conventional mortgage that’s owned by either Fannie Mae or Freddie Mac
• The mortgage is at least 1 year old
• Your loan is a “first-lien mortgage,” which means your lender will be repaid first if you default on the mortgage and the bank is forced to sell your home
• The property is a primary residence, second home or investment property
• You’re at least 60 days past due on the mortgage, or your lender has determined you’re no longer able to afford your monthly payment.

Additionally, your loan servicer will check that you have a regular income. Unemployed borrowers might be eligible for a different program through unemployment forbearance.

How loan modifications work

Lenders are often willing to adjust the terms of a loan because it’s less expensive and time-consuming than going through the foreclosure process. Depending on the lender and the program, you might be able to:

• Lower your interest rate: Decreasing your mortgage rate by one or two points can substantially lower your monthly payment. But make sure to ask if the interest rate will go back up. Some lenders use a step-up approach, in which your interest rate and monthly payment gradually increase for the rest of the loan term.
• Extend your loan term: Extending your mortgage term by several years will lower your monthly payments, which can put some wiggle room in your budget. However, you’ll pay more interest over the life of the loan.
• Switch loan types: If you have an adjustable-rate mortgage and your payments change periodically, your lender might be willing to convert your loan to a fixed rate. Because the rate won’t change, your payments could become more predictable and manageable.
• Reduce the principal owed on your loan: The lender might also lower the principal portion of your loan so you have less to pay off. This type of modification is rare because it essentially gives the borrower free equity. If you’re given this option, talk with a tax adviser about whether the principal would be considered taxable income.

Learn More: What Is a Mortgage Rate and How Do They Work?

How to get a loan modification

Learning how a loan modification works can help you determine if you qualify. Here’s how you generally go about getting one:

Contact your loan servicer

Call your loan servicer to discuss loan modification and other payment assistance programs they might offer. Be honest and explain why you’re behind on payments and how you propose to get back on track.

If you’re eligible to apply for a loan modification, ask about next steps and which documents you need.

Gather proof of your financial circumstances

The lender will need proof of your financial situation. To show how much you earn and how much you’re spending on basic expenses, gather your:

• Recent tax returns
• Pay stubs
• Monthly bills
• Asset statements
• You might also need to supply an IRS Form 4506-T, which allows your lender to access your tax information from the IRS

Get to work writing a hardship letter, which explains how you fell behind on payments and how you hope to rectify the problem. Your other documentation should support this information.

Submit your application

Once you’ve gathered the materials and consulted with a lawyer, you’ll submit the application. The lender should get back to you within 30 days.

Before officially agreeing to the mortgage modification, make sure you understand how your loan terms will change and how the lender will report your account to the credit bureaus.

Go through the trial period

To make sure you can handle the new monthly payment, the lender might impose a trial period of three months. If you make three timely payments, the lender will agree to permanently modify your loan terms.

Check Out: How to Refinance Your Mortgage in 6 Easy Steps

Alternatives to mortgage loan modification

Mortgage modification isn’t your only option if you’re having trouble making your monthly payments. These alternatives can help you get back on track:

Mortgage forbearance

Best if: You’re experiencing a temporary, short-term financial hardship.

A mortgage forbearance plan allows you to temporarily suspend or reduce your mortgage payments for a specific period of time. After forbearance ends, you’ll need to resume regular payments and repay anything missed during the forbearance period. It’s different from loan modification because you only change the loan terms temporarily.

Refinancing your mortgage

Best if: You have good credit and qualify for favorable loan terms.

A mortgage refinance involves taking out a new mortgage, paying off the old loan and paying down the new mortgage over time. If you’ve paid down some of your mortgage since closing the original loan, then your refinanced mortgage will be based on a smaller principal — which helps lower your new payment. Additionally, if you qualify for a lower interest rate, then refinancing could further lower the monthly payment.

Credible can help homeowners find a favorable refinance rate. Just answer a few questions, and you’ll be able to compare multiple loan quotes. The whole process takes just a few minutes.

Declaring bankruptcy

Best if: Several of your debts have become overwhelming, but you have income and want to repay your debts over time.

If you can’t get a mortgage modification or refinance the loan, you might consider Chapter 13 bankruptcy. This legal proceeding allows consumers to catch up on debt payments while keeping assets such as a home or car.

To qualify, you must earn a regular income, show that your debt doesn’t exceed certain limits and meet a few other requirements. During the filing process, you create a plan to pay back some or all of your debt over a course of three to five years. If you successfully complete the plan, you can keep your home.

About the author

Kim Porter

Kim Porter is an expert in credit, mortgages, student loans, and debt management. She has been featured in U.S. News & World Report, Reviewed.com, Bankrate, Credit Karma, and more.

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