A home loan or mortgage modification is a relief plan for homeowners who are having difficulty affording their mortgage payments. Borrowers who qualify for loan modifications often have missed monthly mortgage payments or are at risk of missing a payment.
Here’s what you need to know to get a mortgage loan modification and stay in your home.
What Is a Mortgage Modification?
Modifying your mortgage can help you avoid foreclosure by—either temporarily or permanently—adjusting the length of your loan, switching from an adjustable-rate to a fixed-rate mortgage, lowering the interest rate or all of the above. Unlike mortgage refinancing, loan modifications don’t replace your existing mortgage with a new one. Instead, they change the original loan.
Borrowers with Fannie Mae- or Freddie Mac-owned mortgages might be eligible for a Flex Modification, which allows lenders to reduce the interest rate or extend the length of your loan (which shrinks the monthly payment amount but doesn’t change the amount owed ).
For homeowners facing hardship due to the coronavirus pandemic, a loan modification can help you reduce your monthly payments so that they fit your current budget. Those who are already in mortgage forbearance can request a modification after the forbearance expires if they still need mortgage assistance.
Under the CARES Act, borrowers with federally-backed loans are entitled to up to one year of forbearance. Although most home loans are eligible for this type of forbearance, approximately 14.5 million home loans are not covered because they are privately owned.
However, not all lenders offer loan modifications, even those home loans covered under forbearance provisions in the CARES Act. So be sure to contact your lender to come up with a doable plan (whether it’s a forbearance, modification or something else) that will prevent you from defaulting on your loan.
Who Qualifies for a Loan Modification?
Borrowers facing financial hardship—for any number of reasons—might qualify for a loan modification; however, eligibility requirements are different for each lender.
Some lenders require a minimum of one late or missed mortgage payment or imminent risk of missing a payment in order to qualify. Lenders also will want to assess what caused the hardship and whether a modification is a viable path to affordability.
In other words, if you lose your job and no longer have any income, a modification might not be enough to get you back on track. However, if you start earning less (due to a job change or other factors), you might still be able to make regular payments, but only if you can reduce the monthly cost.
There are several reasons why people might no longer be able to afford their current mortgage payments, which might qualify them for a modification. Lenders will likely ask for proof of hardship. These reasons include:
- Loss of income (due to a drop in wages or death of a family member)
- Divorce or separation
- An increase in housing costs
- Natural disaster
- Health pandemic
- Illness or disability
If you’re suffering from financial hardship, be sure to talk to your lender right away. Find out whether you qualify for a loan modification, per their rules, and if that solution makes sense for you.
How to Modify Your Home Loan
There are several ways your mortgage lender can modify your home loan, from reducing your interest rate to making your mortgage longer in order to lower your monthly payments.
Reduce the Interest Rate
Shaving your interest rate can reduce your monthly mortgage payments by hundreds of dollars. A $200,000 mortgage payment with an interest rate of 4% on a 30-year fixed-rate loan is about $955 per month, compared to the same loan with an interest rate of 3%, which comes out to $843 per month.
This is similar to refinancing your loan, but the difference is that you don’t have to pay closing costs or fees.
Lengthen the Term
Extending the length of your loan is another strategy lenders use to make the monthly payments more affordable. For example, if you have a $100,000 mortgage at an interest rate of 4% with 15 years left, you would pay $740 per month. If you extend that loan by 10 years, you end up paying $528 per month. Keep in mind, you’ll pay more interest over the life of the loan if you extend it.
Switch from an Adjustable-Rate-Mortgage to a Fixed-Rate Mortgage
Switching from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage might not lower your existing payments, but it could help protect you from rising interest rates down the road.
Since ARMs are set up to have floating rates, they change with the market. For example, if your interest rate is 3.5% and the average rate rises to 4%, so will your rate. This can be a bad scenario if you’re in a rising-rate environment. By locking in your interest rate, you’re guaranteed to pay the same interest rate over the life of your loan, regardless of what the market does.
Roll Late Fees Into the Principal
If you have accrued past-due charges on things like interest, late fees or escrow, some lenders will add that to your principal balance and reamortize the loan. That means the amount you owe will be spread out over time with the new balance. If you extend the length of your loan, you might end up paying less in monthly payments even though you owe more toward your principal.
Reduce the Principal Balance
In rare circumstances, lenders will actually lower the amount you owe, also known as a principal modification. These were more common during the housing crisis when loose lending standards prevailed and home values tanked, leaving many borrowers underwater with their mortgage.
Whether a lender decides to reduce the principal likely depends on the current local housing market, how much you owe and what their loss would be if they went this route versus a foreclosure.
All or Some of the Above
Some borrowers might need a combination of actions in order to make the monthly mortgage bill manageable. Depending on your need, a lender might reduce the interest rate and extend your loan so that your monthly mortgage payment is reduced in two ways, without touching the principal balance.
The lender likely will go through a cost-benefit analysis when assessing the type of modification that makes sense for both parties.
Will Modifying My Mortgage Hurt My Credit?
If the modification is federally backed (i.e. owned by Freddie Mac, Fannie Mae, VA, FHA or USDA) and is a result of the coronavirus, then it will not be reported to the credit bureaus per the CARES Act.
Otherwise, some loan modifications might be reported as settlements or judgments, which could result in a ding to your credit. Be sure to talk to your lender about if their policy is to report modifications. However, a loan modification is not as damaging as a foreclosure.
How Can I Apply for a Loan Modification?
Homeowners who are facing financial hardship that makes it impossible to fulfill the mortgage contract should get in touch with their lender or servicer immediately, as they might be eligible for a loan modification.
Typically, lenders will ask you to complete a loss mitigation form. Because foreclosures are so costly for investors, a loss mitigation form helps them look at alternatives, such as loan modifications, to figure out what makes the most financial sense.
Be prepared to submit a hardship statement; mortgage and property information; recent bank statements and tax returns; profit and loss statements (for those who are self-employed) and a financial worksheet that demonstrates how much you’re earning versus spending.
If your loan modification application is denied, usually, you have the right to appeal it. Because rules vary by lender, find out when the appeal deadline is. Next, you’ll want to get precise information on why your loan was denied, as this will help you prepare a better case in your appeals.
There are many reasons why you might not qualify, from not providing sufficient proof of hardship to having a high debt-to-income ratio (DTI). A high DTI means that you have a lot of debt relative to your income, which might signal that you can’t afford your mortgage, even at a modified amount.
Working with one of our experts who specializes in mortgage modifications can improve your chances of getting approved for a loan modification.