Should You Get a Mortgage Loan Modification? | Mortgages and Advice

You close on a loan, and you plan to make payments far into the future. But what happens if your income drops and that once-affordable loan payment is out of your budget?

Loan modification could give you a way to keep your loan despite your changed circumstances. Modification might be an option for a few types of loans, including student loans. Mortgage servicers offer modification to help homeowners stay out of foreclosure.

A mortgage loan modification is a change to the terms of a home loan. The purpose is to make your payments affordable again so you can continue repaying your mortgage and hold onto your home.

Mortgage servicers try to use loan modification to prevent default or bring mortgages out of delinquency. “They would rather make sure that payments are coming in rather than go through the expense and challenges of trying to foreclose,” says Igor Roitburg, managing director at Stretto, a bankruptcy services and technology firm that offers an online platform for compiling mortgage modification documents.

The following characteristics of a loan can change in a modification:

If you aren’t able to make your mortgage payments and you want to stay in your home, a modification is usually a good option, according to Roitburg. “The single largest benefit that borrowers would expect is that they avoid foreclosure,” he says.

A loan modification can affect your credit. “I probably would see it reported on my credit report as ‘modified terms,'” says Scott Griffin, a mortgage broker who is the founder and CEO of Scott Griffin Financial. But the modification could have a net positive effect because the servicer might remove notices of late payments and bring the account current again, he says.

Read the terms of the modification carefully, and watch out for any nonstandard features, like a balloon payment requiring you to pay a large amount at once when the loan term is over.

A modification could give you more time to pay off your loan, and as a result, the total interest you pay could go up. But paying extra interest over time is often worthwhile if your goal is to keep your home, Roitburg says.

“I don’t often find many negatives to a modification, other than it may be uncomfortable to have that kind of conversation with a service provider, talking about a personal life event and the need to ask for help,” says Griffin.

To be eligible for a loan modification, you need to be in default or you must be about to default. A homeowner could be in this situation because of a serious event, such as a job loss or the death of someone in their household. Applying for a loan modification involves documenting this event for your servicer and demonstrating how much you are able to pay each month going forward.

You can start the process by calling your mortgage servicer and explaining that you aren’t able to pay your mortgage. The servicer will send you a package of application forms in the mail or will give you access to the package online.

You fill out the application and provide proof of the hardship you experienced. You need to document your income by showing pay stubs and a tax return if you’re an employee, or bank statements and other information about your business income if you’re self-employed. You might also be asked for information about your assets and debts.

After you return the package, the servicer checks to see that you’ve provided the required documents. “Usually there’s some back and forth as to what’s missing,” says Roitburg. “And frankly, that’s one of the biggest challenges in the mortgage modification space, is trying to get that complete package.”

Once the package is complete, the servicer evaluates your application. If it decides you’re eligible for a modification, it sends you a document outlining the terms. You sign this and send it back to the servicer.

Often, there is a trial period. For example, if you make your first three modified payments on time, the servicer will make the modification permanent.

If the servicer rejects your application, you’re typically allowed to appeal the decision and ask the servicer to look at your documents again. But at this point, you might need to consider other options. “Anecdotally speaking, I think appeals are almost never successful,” Roitburg says.

The process is similar for government-backed and conventional loans, although possible modifications can vary depending on the type of loan.

Refinancing means taking out a new mortgage and using it to pay off your existing mortgage. A refinance can give you a new interest rate and loan term, which might result in a more affordable payment.

Compared with a modification, an advantage of refinancing is that you might get to take some cash out of your home equity if you borrow more than you owe on your existing mortgage. You can’t convert equity to cash through a modification.

On the other hand, refinancing involves paying closing costs, such as appraisal fees, origination fees and title search fees. These costs add up to $5,000 on average per refinance, according to Freddie Mac. A modification typically doesn’t cost anything to set up.

Another downside of refinancing is that it can change how your payments are allocated to principal and interest, especially if you’ve had your current mortgage for several years. A refinance resets your payment schedule so that you’re starting at the first payment on a new loan. You might then build equity more slowly for a while, because a large portion of each payment goes to interest at the start of the loan term.

“The longer you’re inside of a mortgage, the more that payment goes to you, the consumer, as a principal reduction,” Griffin says.

You may not get to choose between a refinance or a modification because you might qualify for only one or the other. “You typically cannot request a modification just because you want a better rate and your loan is not otherwise in danger of default,” Roitburg says. If you aren’t about to miss a mortgage payment, refinancing might be the only way to change your loan terms.

“I’m going to guess that most individuals and families will have a stronger benefit from modifying a mortgage than they will from refinancing a mortgage. They avoid the additional cost,” Griffin says. But he says that if they aren’t approved for a modification, refinancing might be worth it, especially if interest rates have gone down since they took out their original mortgage.

A foreclosure is a long, stressful process that can cause serious harm to your credit for the seven years it remains on your credit report. So if you’re struggling to pay your mortgage and you can’t get approved for a modification or refinance, you probably want to consider other ways to avoid foreclosure.

Entering into forbearance might help if you’re dealing with a temporary hardship. In forbearance, you stop making payments on your mortgage or make lower payments for a short time. You agree to repay the payments you miss gradually or at a set time in the future.

But if your finances have changed permanently – or if you don’t want to stay in your home – then you might need a way to get out of your mortgage.

It’s ideal to sell your home for more than you owe on your mortgage. You don’t have to convince your servicer to sign off on the sale, and your servicer might agree to pause the foreclosure process while you find a buyer.

That avenue isn’t open to you if your mortgage is underwater, meaning that your house is worth less than your remaining mortgage balance. In that case, your lender might allow a short sale. You sell the property for less than you owe, and the lender takes the money. The lender might forgive the rest of your balance, or you might still be on the hook for the difference depending on your state’s law. Your credit will take a hit, and you likely won’t qualify for a new mortgage for at least two years.

Alternatively, your servicer could agree to a deed in lieu of foreclosure. You give the servicer the title to your home, and you don’t have to come up with the remainder of what you owe. Generally, you can’t have other unpaid loans against your home equity. And like a short sale, a deed in lieu of foreclosure will hurt your credit and prevent you from qualifying for a mortgage for at least two years.