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If you’re struggling with financial hardship and have fallen behind on your mortgage, you may benefit from a loan modification. Learn how to request a loan modification from your lender to avoid foreclosure and prevent losing your home.
What is a loan modification?
A loan modification is a formal agreement between a borrower and a lender that modifies or amends a pre-existing loan. The original terms of the mortgage can be modified to lower the unpaid principal balance, interest rate, or a combination of both, which in turn lowers the monthly mortgage payment.
Most banks are in the business of lending, not owning real estate. They make money when a loan is performing or paying on time, not when it's delinquent. When homeowners fall behind, banks protect their interest in the property by initiating foreclosure. This legal process can be expensive and time-consuming. Most banks would prefer an alternative solution that gets the homeowner back on track and paying again -- avoiding foreclosure if possible.
Loan modifications are designed to adjust the terms of the loan to make the loan more affordable in the long run and, hopefully, keep the borrower from defaulting again in the future.
Qualifying for a loan modification
Qualifying for a loan modification program greatly depends on your personal financial situation and the length of time your loan has been in default. The longer a loan is delinquent, the less likely the mortgage company will be to consider a modification. Additionally, the homeowner will likely need to provide evidence of hardship, explaining what circumstance has negatively impacted their ability to repay the loan, such as:
- Death of a spouse or income provider.
- Temporary loss of income.
- Medical illness.
Loan modifications are one loss mitigation option. Loss mitigation is a term used in the mortgage industry that refers to the mortgage company's or loan servicer's process to mitigate a loss -- or in other words, prevent foreclosure. Most servicing companies or lenders will want you to apply for loss mitigation, and they will determine whether you qualify for a modification. If you simply cannot afford a mortgage any longer, an alternative solution like a deed in lieu or short sale may be a better option for both parties.
Applying for a loan modification
If you feel you could benefit from a loan modification, reach out to your lender or servicer's loss mitigation department as soon as possible requesting a loan modification application.
Most application packages will ask you to submit a hardship letter in addition to your current financial information, which could include:
- Tax returns.
- Proof of income, which could be copies of pay stubs.
- A current financial statement or financial summary.
- Estimation of property value.
- Bank statements.
- Proof of hardship (such as death certificate, medical statements, divorce papers, etc.).
Lenders will look at the entire packet in addition to reviewing your credit score, debt-to-income ratio, and current loan terms to help determine whether you qualify.
Some banks will have their own modification programs, while others will use government-backed programs like:
- Freddie Mac's Flex Modification program.
- Fannie Mae's High Loan-to-Value Refinance.
- Freddie Mac's Enhanced Relief Refinance program.
If you have a Freddie Mac or Fannie Mae mortgage, you may be eligible for one of these programs.
While you can apply for a loan modification yourself dealing directly with your bank or lender, you can also use a HUD-approved housing counselor or an independent, third-party loan modification company to help you with this process.
A loan modification company charges a fee for its services. A HUD-approved housing counselor offers their services for free since they are a government agency.
Both represent the homeowner through the modification request process, helping them gather and submit the required paperwork and negotiate terms with the bank, and they can even help counter if the application is denied or assist in filing an appeal.
A HUD-approved housing counselor is often a safer, more affordable way to go, but if you do work with a loan modification company, make sure they have verifiable experience getting affordable home modifications approved for other homeowners as well as experience negotiating with your bank or lender. You’ll also need a firm understanding of what fees they charge for their service.
Important factors to consider
Remember that the bank or servicing company is working for the lender's best interest. You may receive an offer that isn't an affordable modification plan. Adjustable rates or step-up plans rarely work. Press your lender to provide you with modification terms that you can sustain in the long run.
Don't feel pressured to accept the first modification offer that comes to the table. Terms are negotiable. Make sure all options for adjusting the terms of the loan have been explored. Depending on what the lender modifies, you could end up paying a lot more over the life of the loan.
There is almost always a positive solution for both parties, one that agrees with the bank's bottom line and is an affordable long-term solution for you. If you need help, remember to find a qualified, experienced, and licensed counselor to help you through this process.
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