Published in: Mortgages | July 1, 2020
By: Dana George
If you are struggling to make your mortgage payments, your lender may be willing to offer a mortgage loan modification. Here's everything you need to know before you apply.
Unlike refinancing, which essentially replaces your current mortgage with a new one, a mortgage loan modification changes the terms of your existing loan. Loan modifications are designed to make payments more affordable for those who are facing financial difficulties. Whether you have a conventional, FHA, or VA loan, you should find modification options to fit the loan type.
The downside of a mortgage loan modification is that lenders may report it to credit bureaus as debt settlement. If they do, your credit score will take a hit. Still, debt settlement is less damaging than foreclosure. If you suspect foreclosure is on the horizon, it's good to know you have at least one other option first.
While this list is not exhaustive, here are some of the ways lenders might modify your loan.
Extended loan term: Mortgage lenders will sometimes offer to extend the period you have to repay the mortgage. Let's say you have a $300,000 mortgage with a 15-year loan at 5.50% interest. Your monthly 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 -- $387 less. Of course, because you are paying over an extended period, you will end up paying more for the loan overall. Had you kept the 15-year mortgage, you would have paid about $440,000 by the time the mortgage was retired. Extending it by five years means you could pay around $495,000, or $55,000 more.
9 in 10 Americans can qualify to refinance their mortgage. With mortgage rates plummeting to multi-decade lows, there's no better time to cut your monthly mortgage payment.
Reduction in principal: Reduction in loan principal is the unicorn of the loan modification world, so rare that it is more legend than reality. It occurs when a lender is willing to actually reduce the amount you owe, making it easier for you to pay. Bear in mind that if it does happen, you would still have to pay income taxes on the reduction.
Loan conversion: If the interest rate on your adjustable-rate loan is rising too rapidly and you can't keep up, some lenders will agree to convert the loan to a fixed interest rate that you can afford.
Deferment: A deferral (sometimes referred to as "postponement") represents a temporary break from loan payments -- generally for a few months. If you have been a model borrower up to that point, 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 can be permanent or temporary (see below). Even a drop of 0.50% can make a difference. You'd pay $1,703 a month towards 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 by $93 to $1,610 per month.
While some lenders offer a permanent reduction in interest rates, others offer a temporary modification that includes a "step rate" feature. With a step-rate modification, your lender tells you how long your new interest rate will be in effect (typically five years). At the end of that time, the interest rate begins to slowly adjust upward, working its way to what is called the "interest rate cap."
Here's an example of how step-rate modification might work, sticking with that same 5.50% rate. You are offered a modified interest rate of 3.50% for five years, with an interest rate cap 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.
Borrowers dangerously close to default are prime candidates for loan modification. Financial hardship may include:
Before calling your lender, contact a counselor approved by the Department of Housing and Urban Development (HUD). HUD counselors are trained to help assess your financial situation and come up with options that will help you pay your mortgage.
Once you have received professional advice, contact your lender. Explain your situation and ask about options. Be prepared to provide the following:
If your first request is turned down, do not be discouraged. The majority of initial applications are denied. Here are some common reasons for denial.
If your application is denied, submit a written appeal within 14 days. If you are denied a second time you cannot appeal again, so make sure to provide every piece of evidence requested during the appeal process.
As bad as it feels to fall behind on your bills, do not lose hope. You are doing the responsible thing by tackling the problem head-on and a loan modification may tide you over until you're back on solid financial footing.
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