What is a mortgage loan modification?
While you might be anxious to become a homeowner, homeownership comes with its own set of challenges. If you’re a struggling homeowner and you’re working hard to make your mortgage payment, your lender might be willing to come up with a mortgage modification. Here is everything you need to know before applying.
What is a mortgage loan modification?
Unlike refinancing, which essentially replaces your current mortgage with a new one, a mortgage loan modification changes the terms of your existing loan. Mortgage loan modifications are designed to make payments more affordable for those facing financial difficulties. Whether you have a conventional, FHA, or VA loan, you should be able to find loan modification options that are right for your loan type.
The downside to a mortgage loan modification is that lenders can report it to the credit bureaus as a debt settlement. If they do, your credit score will take a hit. Yet debt settlement is less damaging than a foreclosure. If you think foreclosure is on the horizon, it’s good to know that you have at least one other option first.
While this list is not exhaustive, here are some of the ways that lenders might modify your loan.
Extended loan period: Sometimes mortgage lenders will offer to extend the period you have to pay off the mortgage. Let’s say you have a mortgage for $ 300,000 with a 15 year loan at an interest rate of 5.50%. Your monthly mortgage payment on principal and interest is $ 2,451. If the lender extends the loan to 20 years, your new monthly payment would be $ 2,064 to $ 387 less.
Of course, because you are paying over a longer period of time, you will end up paying more for the loan as a whole (because of the interest). If you had kept the mortgage for 15 years, you would have paid about $ 440,000 when the mortgage was paid off. Extending it for five years means you could pay around $ 495,000, or $ 55,000 more. In this case, a mortgage loan modification gave you a lower monthly payment, but costs more due to additional years of interest payments.
Principal reduction: Reducing the loan principal is the unicorn of the loan modification world, so rare that it is more legend than reality. This happens when a lender is willing to reduce the amount you owe, making it easier for you to pay. Keep in mind that if this happens, you will still have to pay income tax on the reduction.
Loan conversion: If the interest rate on your variable rate mortgage goes up too quickly and you can’t keep up, some lenders will agree to convert the loan to a fixed interest rate you can afford.
Adjournment: A deferral (sometimes called a âdeferralâ) is a temporary interruption in loan payments – usually for a few months. If you’ve been a model borrower before, your lender may allow you to skip a few payments. These missed payments would then be added to the end of your loan.
Lower interest rate: This is probably the most common form of loan modification and it can be permanent or temporary (see below). Even a 0.50% drop can make the difference: You would pay $ 1,703 per month in principal and interest on a $ 300,000 30-year mortgage at 5.50%. If the lender lowers the interest rate by 0.50%, the payment would drop from $ 93 to $ 1,610 per month.
How a tiered interest rate change works
While some lenders offer a permanent reduction in interest rates, others offer a temporary modification that includes a “graduated rate” feature. With a stepped rate change, your lender tells you how long your new interest rate will be in effect (usually five years). At the end of this period, the interest rate begins to slowly adjust upward, reaching what is called the âinterest rate capâ.
Here is an example of how changing the rate in steps might work, keeping the same rate of 5.50%: You are offered a modified interest rate of 3.50% for five years, with a rate cap. interest of 6.25%. After five years, the rate increases by a maximum of 1.0% each year until it reaches 6.25%. Your mortgage remains at 6.25% for the remainder of the loan.
Who is eligible for a mortgage modification?
Borrowers dangerously close to default are prime candidates for mortgage modification. Financial difficulties can include:
- Insurmountable medical bills
- Divorce or separation
- Death of a family member
- Increased living expenses
How to get the ball rolling
Before calling your lender, contact an advisor licensed by the Department of Housing and Urban Planning (HUD). HUD advisors are trained to assess your financial situation and provide options that will help you make your mortgage payment.
Once you’ve received professional advice, contact your lender. Explain your situation and learn about loan modification options. Be prepared to provide the following information:
- Proof of income, place of work and how much you earn
- Most recent tax return
- List of expenses, including accommodation, food, clothing, transportation and other living expenses
- Letter of explanation in which you describe what led to your current financial difficulties
What to do if your loan modification request is denied
If your first mortgage modification application is denied, don’t be discouraged, the majority of initial applications are denied. Here are some common reasons for refusal:
- Your application is incomplete
- You can’t afford the new monthly payment
- Your “difference” does not meet the lender’s standard
- Your debt-to-income ratio is too high
- The lender believes you can pay your current payment
- You have already been approved for a loan modification (within the last 12 months)
- You got a trial modification period and you missed or were late with a mortgage payment
If your request is denied, file a written appeal within 14 days. If you are denied a second time, you can no longer appeal, so be sure to provide all the evidence requested during the appeal process. Remember, as difficult as the process of modifying a mortgage can be, it is easier than facing a foreclosure.
Falling behind on your bills isn’t the worst thing in the world. You act responsibly by tackling the problem head-on, and a mortgage modification can put you off until you’re back on a solid financial footing.