A loan modification is an agreement between a borrower and a lender to re-negotiate the terms of an existing mortgage in order to make a borrower’s payments more affordable. For the borrower, loan modification is a way to prevent or forestall default and possible foreclosure on a home. For a lender, loan modification offers a way to avert the costs of foreclosure and sale of a repossessed property. In many cases it can be less expensive for a bank to modify the terms of an existing mortgage than to force a borrower into insolvency and/or bankruptcy.
In order to get a loan modified, a borrower will generally have to prove financial hardship and convince a lender that he or she cannot make the agreed upon monthly payments stipulated in the original agreement. The borrower will need to present compelling evidence including income and expense records, paystubs, bank statements, proof of unemployment or divorce, accounts of outstanding debts or bills, etc.
A lender may also be persuaded to modify a mortgage if it determines that a short sale of the property will not cover the amount of the original loan.
Before agreeing to a loan modification, a lender will want to make sure that a borrower can meet the new obligations set forth in the modified loan. Once a lender has decided to grant a loan modification, it can be accomplished in several ways:
- Payments can be temporarily skipped (forbearance) and added to the end of the loan term.
- The total amount of the principal can be reduced.
- The interest rate can be reduced.
- A variable interest rate can be changed to a fixed rate, or visa versa.
- The loan’s repayment term can be extended.
- Any combination of the above.
Since a modification is different from refinancing, it is important to remember that there are no set rules. Loan modification is a negotiation between a borrower and a lender that, ideally, will result in a win-win situation for both parties – the borrower gets to remain in his or her home and the lender gets continued payments.
Drawbacks to a mortgage loan modification do exist. Since the modification process usually begins after the borrower is behind or in default, there will be a negative impact on his or her credit report. Also, if a loan is modified by extending the repayment term, additional interest payments may actually increase the long-term cost to the borrower.
Currently, the federal government’s Home Affordable Modification Program requires mortgages owned by Fannie Mae and Freddie Mac, who hold nearly half of the nation’s outstanding mortgages, to work with eligible borrowers to modify their loans.
Also, according to the terms of a recent settlement, five major banks (Wells Fargo, JPMorgan Chase, Citigroup, Bank of America, and Ally Financial) who, together, handle payments on most of the other half of the nation’s outstanding home loans, are also required to provide relief in the form of loan modification or refinancing to eligible borrowers, especially those whose homes are underwater or who are at imminent risk for default.Jeffrey Sterner writes about personal finance, Veteran issues and gives real estate debt advice for Debt.org.