Barbara Sadler: Is A Loan Modification Bad For Your Credit?

One concern that many people have about getting a mortgage loan modification is how it will affect their credit rating. They may be in a position where a loan modification would help them, but they hesitate to pursue one for fear of harming their credit. At first, it might seem a minor issue. After all, a foreclosure is one of the worst things that can happen to your credit rating, so doing what you can to avoid it might seem like a no-brainer. But for those who depend on good personal credit – such as small businesspeople who need to maintain a healthy credit line to keep operating – there might be legitimate reasons to be concerned.

Long-term credit impacts may be positive

Depending on how your lender reports it to the credit bureaus, a loan modification can result in a drop in your credit rating. But at the same time, it’s going to have far less negative impact than a foreclosure or string of late payments, so in that case, it can actually help your rating in the long run. In most cases, borrowers seeking a loan modification are already going to be in some kind of financial difficulty. Many will have already begun missing payments or making late payments (defined as 30 days or more lately for credit reporting purposes), so they’re already suffering some negative effect on their credit rating. In fact, some lenders may not consider a loan modification until a borrower begins to fall behind on their mortgage, although this is not the case of all lenders or a requirement of the government’s Making Home Affordable program. Lenders will often report a loan modification to credit bureaus as a type of settlement or adjustment to the terms of the loan.

If it shows up as not fulfilling the original terms of your loan, that can have a negative effect on your credit. But the effect will be less and of shorter duration than a string of missed payments or a foreclosure would have. On the other hand, some lenders may not report a change as a settlement, meaning your credit would be unaffected. In this case, your credit rating could even improve, because your monthly payment would be reported as decreased. When negotiating a loan modification, ask your lender how they report it – they may even agree not to report it as an adjustment, particularly if you’ve been a good customer over the years. One particular credit problem has been associated with trial loan modifications under the government’s Making Home Affordable Program. In a trial modification, the homeowner is given a reduced payment schedule which, if maintained for three months, can be made permanent. However, some homeowners are reporting that their lenders are reporting them as failing to stay current on their payments during this period, since the reduced payment schedule is not yet official.

Trial modifications should be listed as current

The government has issued guidance to lenders that trial modifications should be listed as current, but on a modified schedule. This may still have a negative impact on your credit, but will not be as severe or last as long as a late-payment report. If your lender is not reporting your modified payments as current, you or your credit counselor can refer them to the guidelines posted on the Home Affordable Modification Program. Finally, it’s important to remember that at loan modification will likely have a different impact on your credit than refinancing your mortgage. A loan modification changes the terms of your existing mortgage, while a refinance is simply obtaining a new mortgage on better terms. A refinance should have no negative effects on your credit, other than possibly a small short-term debt due to the fact you’ve taken out a new loan. But otherwise, the effects should be minimal. A horrible economy, large lending losses and an uncertain future have everyone trying to insulate themselves from what I call a credit winter by tightening their belts and doing what they can to reduce risk and further losses. You are modifying your loan; bankers are cutting credit lines and raising interest rates. Because you are in the process of modifying your mortgage and have not completed the process, my initial reaction is your credit card limit is being reduced due to environmental issues and not because of your modification. However, if you are modifying your mortgage because you could not make your mortgage payment and paid late once, twice or more, then your credit card limit may have been decreased due to that negative activity on your credit report. Looking at your credit reports will tell you how your mortgage loan is being reported.

The modification, once completed, may negatively affect your credit score. It all depends on how the lender reports the change. For example, if the modification is considered a new loan and your principal was decreased, the lender may report your original mortgage as settled or charged off, which would be a fairly big negative for credit scoring. But if by modifying the loan you are avoiding a foreclosure, then you are avoiding a much larger negative entry on your credit report that would be far more devastating to your credit. If the modified loan is not considered a new or settled loan by your lender, then the only negative effect on your credit associated with the modification should be any late payments you made on the loan. Should you end up with a negative entry on your report due to the modification, it’s not the end of the world. Although the negative data will stay on your credit report for seven years, it will decrease in importance with every month that passes. New positive payment information can stay on your record for much longer and will help rebuild your credit usually in a year or two. Finally, be aware that credit may continue to tighten, meaning you will need a better credit record than usual to keep your credit lines in place. This will make saving for that rainy day or emergencies all the more important.

Mortgage modification is growing in popularity with more and more people facing foreclosure. Banks are turning to this method as an alternative to foreclosure and in some cases it is a good thing. Mortgage modification can help you under the right circumstances. However, you will want to make sure that you are getting the best deal before agreeing to anything.
Here is the good, the bad, and the ugly about mortgage modification.

The good thing about mortgage modification is that it can help you stay on your feet. Mortgage modification is designed as an alternative to foreclosing on a house or filing bankruptcy. If you are in deep, you will need help from somewhere. If you have to foreclose on your house, it will hurt your credit badly. You might not be able to buy another house for years. Therefore, anything you can do to get out of foreclosure is a good thing. Modification can help you by lowering your interest rate, lowering your payment, or getting rid of late payments for you. If you are behind on your payments, it can seem very overwhelming. If the mortgage lender is helpful, it can be a great asset to you and your financial situation.

Mortgage modification is not always in your best interest. If you can leave your mortgage alone and avoid modification you will usually be better off. A mortgage modification usually will negatively affect your credit. Anytime you do not pay off a loan like you agreed to pay it off, it can be reported to the credit bureaus. Usually you will have many late fees and missed payments if the house is close to foreclosure. Therefore, your credit score can be negatively affected from the mortgage modification process. Sometimes, mortgage modification is a big mistake. The mortgage lenders may just be in it to help them out and they don’t care about you. When this happens, just stay away from their offers and stick with your loan. One such example is in the area of blind loan modification. Blind loan modification is when the bank sends you an automated offer that is designed to get you to modify your loan. It will come with some seemingly attractive terms that entice you to accept the offer. However, when it comes down to it, the offer is not in your best interest. It is designed to help the bank in the long run and make them more money. The bad thing about blind loan modification is that the offer is generated by a computer instead of by a person.

It is not a special offer that was designed on your behalf from the bank. The bank will not be able to discuss it with you in detail. They just want you to accept the offer and start making your payments. Make sure that you understand what you are agreeing to with these types of deals. A loan modification is exactly what it sounds like: a change in the terms of a loan. The objective: achieve a lower, manageable monthly payment. Modification is an alternative to the messy process of foreclosure, bringing relief the homeowner (who gets to stay put) as well as the lender (which doesn’t incur the expense and time lost to foreclosure). It’s sort of a win-win, especially if the borrower is informed, organized, proactive and persistent.

Incidentally, loan modifications, like loan applications themselves, are for everyone who complained they’d never use algebra in real life. Payments are the result of an algebraic formula involving three variables:

principal, interest rate, and term (length of the loan). In a loan modification, applicants attempt to alter one or more of these variables to reduce their payments.

• Principal reduction: We begin with the holy grail of loan modifications — eliminating a portion of your original debt and recalculating your payments based on this new figure. Because the result is a direct hit to their bottom line, lenders are reluctant to saw off a portion of the principal; they much prefer to restructure troubled loans in other ways. If you are approved for a principal reduction, however, consult with a tax professional; the forgiven portion of your loan may be subject to income taxes as regular income.

• Lower interest rate: Your lender might be willing to negotiate a break on your interest rate. In some cases, a quarter or even an eighth of a point can make all the difference. This cut may be temporary, however; know the details of your modification and, if your reduction isn’t permanent, be prepared for when your rate, and payment, pop up again.

• Extended term: Lenders sometimes are willing to recalculate a loan based on a longer payoff schedule. A 15-year loan can stretch to 20 or 30. Be wary, however, of lenders offering to extend loans beyond 30 years; if the plan is to lengthen your mortgage to 40 years or more, scrutinize the modification for prepayment penalties. Make sure you won’t incur a sanction if you sell the house, or recover yourself sufficiently to refinance into a shorter loan.

• Refinance the loan: Modification generally is for borrowers who are in trouble on their mortgages and unable to refinance. However, under certain circumstances the house has plenty of equity, or the borrower has untapped resources even a problem borrower can refinance. Replacing your current loan for one with a lower interest rate, a longer term, or both, could drop your monthly payment substantially. The downside: There will be closing costs, and assuming you stay put for the duration of the loan you probably will incur higher total interest costs. Loan modifications, by contrast, can be completed faster and without processing fees.

• Convert to a fixed-rate: If you have a variable interest-rate loan that’s been ticking toward the point of breaking your budget, you’re definitely a candidate for a fixed-rate loan.

• Postpone payments: Suppose your financial bind is temporary. You’re caught between jobs (but you’re undeniably employable), you’ve encountered unanticipated medical expenses, or there’s been some other setback. If you’ve been a model mortgagor, you might be able to skip a handful of payments. Those payments are not forgiven; they’re tacked onto the end of your loan, so you’ll have to postpone your mortgage-burning party, or there will be a larger balance due when you sell your house.

While you’re at it: Look for other ways to save on your payments, especially if you are having your property taxes and insurance put into escrow.

• While county property assessors rarely make significant errors on the taxable value of typical homes, it’s never a bad idea to inspect your annual notice. A mistake in your overall value (overstating the number of bedrooms or bathrooms, or the size of your property) or the value of add-ons (a pool, or out-buildings, size of your property) could add substantially to your tax bill. Do your research, and then visit your county property appraiser’s website to learn how to challenge your valuation.

• Make certain your homeowner’s insurance is right for your needs. Review your deductibles. Don’t pay for coverage you don’t need. Shop your policy; prices can fluctuate widely within the same area, depending on how companies weigh various risks.

• Review your private mortgage insurance (PMI) status. Rising property values are your friend: Homeowners often can eliminate PMI premiums if their loan balance is less than 80% of their home’s market value.

Who Can Qualify for a Home Mortgage Modification?

Homeowners who have fallen behind on their payments, or are in danger of falling behind, and are faced with potential foreclosure as a result of unanticipated or unavoidable (and demonstrable) financial hardship may be candidates for loan modifications.
Examples of financial troubles include, but are not limited to:
• Unemployment or other loss of income
• Increased living expenses
• Medical bills
• Divorce or separation
• Death of a family member
• Disability
In virtually all circumstances, lenders will examine carefully the borrower’s claims and weigh them against the likelihood that when the crisis passes, the customer will be able to fulfill the obligations of the modified loan.

What Types of Loan Modification Programs Exist?

If nothing else, the Great Recession and mortgage crisis made lenders and mortgage-servicing companies more attuned to the needs of at-risk homeowners. (It helped to have Congress and the White House breathing down their necks, but let’s not quibble about progress.) Nowadays, most lenders have assorted programs designed to see borrowers through tough times while keeping them in their homes. If yours doesn’t, ask your lender or a Housing and Urban Development-approved counselor about your eligibility for programs that can assist you through the modification process.
Two federal programs adopted in response to the mortgage crisis are no longer with us. But substitutes are in place.
HAMP — the Home Affordable Modification Program — expired at the end of 2016. Its successor is the Flex Modification program, overseen by Fannie Mae and Freddie Mac. Borrowers whose mortgages are subject to Fannie or Freddie may qualify. HARP — the Home Affordable Refinance Program — helped refinance underwater homeowners into new, more affordable mortgages. HARP expired at the end of 2018. Now there are Fannie Mae’s High Loan-to-Value Refinance Option and, from Freddie Mac, the Enhanced Relief Refinance program.

What Steps Are Involved in a Mortgage Modification?

When you’re certain there’s going to be trouble, contact your mortgage holder (mortgagee) immediately, over the telephone or online. Explain your situation and inquire about the available options. Other factors being equal, lenders are more likely to work with at-risk clients who are proactive about their predicament. Modification applications vary from lender/service to lender/servicer. Most likely, you will be asked to provide proof of your financial hardship; some will require a letter explaining your hardship and why a modification is necessary. Beyond that, be prepared to document your finances in detail, no less than when you applied for your mortgage in the first place. Some of the information you’ll be asked to provide:
• Income: How much you earn, its sources, and other financial resources.
• Expenses: A record of your spending — how much, and where it goes; be prepared to categorize (housing, transportation, food, clothing, etc.)
• Documents: Back up your statements with paystubs (or profit/loss statements if you’re self-employed), bank and credit card statements, loan agreements, investment reports, recent tax returns and other vital documents.
Just like a mortgage application, a loan modification application can take hours to complete. Once you’ve gathered the documents and related information which can be time consuming, even for the well-organized applicant there will be forms to fill out. Also, your lender is likely to be extremely particular about how it wants information formatted. Once everything is submitted, make certain you keep your information updated, with replacement documents in timely order. A common complaint among loan modification applicants is that lenders ask for the same document over and over, most often because the original documents have gone out of date. (Yours isn’t the only modification they’re processing, after all.) It may take weeks before the lender provides an answer, and weeks more to alter your loan, if you get approved. (A majority of applications are denied.) Meanwhile, believe it or not, the clock continues to tick on foreclosure.