Life circumstances often change, and sometimes that change means that our financial situation changes. Refinancing is a good option, but not everyone can qualify. Unforeseen circumstances like a loss of income, natural disaster, or divorce can put homeowners in a tight spot — facing foreclosure.
When this happens, mortgage modification can be a good solution to avoid damaging activity to credit scores and preserve homeownership.
What is a Mortgage Modification?
A mortgage modification is an agreement with your existing lender to alter the terms of your existing mortgage. Modifications include changes in payment amounts, due dates, length of the loan, and interest rate. A mortgage modification is a good option for those facing severe or extended hardships and who do not qualify for traditional refinancing.
Benefits of Mortgage Modification:
- Resolves delinquencies
- Less damaging than a foreclosure
- Gives a fresh start, possible lower payments
- Allows borrowers to stay in the home
When a borrower faces foreclosure, it is in the bank’s best interest to work with the borrower. This is also true if the borrower has a long, established history of making timely payments and has only fallen behind due to circumstances.
Common Types of Mortgage Modifications
From the underlying cause to the solution, no two mortgage modifications are exactly alike. Lenders will perform a cost-benefit analysis to determine the best approach to saving your mortgage from foreclosure. Some of the common modification options include:
Reduce the Interest Rate
One of the biggest impacts your lender can make to your monthly payments is an interest rate reduction. Homeowners can shave hundreds off of their monthly payments simply by going down 1% on their interest rate. With an interest rate reduction, borrowers benefit from a refinance without the hassle of the closing costs.
Longer Loan Terms
Another strategy to lower monthly payments is to spread the loan out over a longer period. If a borrower has fifteen years left, the lender can easily extend the loan terms to thirty years. This modification will cost the borrower significantly more in interest over the life of the loan. But, for homeowners that are in financial trouble, it is a practical solution.
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Roll Late Fees Into the Principal Balance
If the borrower has a significant balance of late fees on the account, the lender can help them catch up and resolve their delinquency by rolling these fees into the loan’s principal balance. This tactic effectively spreads out the balance of these fees over a longer period of time for cash-strapped borrowers.
Deciding between a refinance and a modification? See if Mares Mortgage can help with a simple prequalification.
Reduce the Principal Balance
Although this approach is less common because it means that the lender is voluntarily reducing your debt without receiving payment, it is not unheard of. Stricter lending practices have mostly prevented the type of predatory lending that made this tactic necessary in the first place. This option depends largely on the housing market and the availability of other alternatives.
Most lenders will make an arrangement that includes a combination of these options to make an existing mortgage more manageable. Lowering interest rates and extending loan terms seem to be the most feasible for most lenders and most situations.
How Does a Mortgage Modification Affect Your Credit Score?
The good news is that the impact of a mortgage modification will be lesser than a foreclosure. Although judgment activity is likely to be reported to the major credit bureaus, it does demonstrate that you tried to work it out.
There is a little bit of a wildcard in this situation, though. Lenders have some flexibility in how they report mortgage modifications. It is good advice to ask your lender what their policy is before signing the dotted line. Try negotiating with your lender — they are not required to report this activity at all. If the lender doesn’t report a debt settlement or delinquent payments, your credit score would not be affected.
Additionally, there is a special program in place for COVID pandemic-related hardships that protects the borrower from negative credit reporting. Similar programs may exist for other reasons, so don’t be afraid to ask about your options.
How to Get a Mortgage Modification
The rules for a mortgage modification vary by lender. This isn’t a step you would take unless you were facing a possible foreclosure and could not afford other methods like refinancing your mortgage.
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Contact your lender immediately and inquire about your options. Some lenders won’t consider a modification until your account is delinquent, but it is a good idea to ask as early as possible — even before you have missed a payment.
Gather your documentation — yes, you will have to prove your hardship exists. Fill out any forms requested by the lender and provide supporting documentation like a hardship statement, bank statements, and tax returns.
Your lender will want to have a good picture of your ability to pay a modified payment and their costs to foreclose on the property. Foreclosure is expensive for the lender, and most will try to avoid it. Unless your debt-to-income ratio is so high that you simply cannot afford the mortgage at all, most lenders will have something to offer.
It is still a good idea to work with a mortgage lawyer who can negotiate a practical deal that will be in your best interest. Remember, mortgage companies know a lot more about what they are getting you into than you do.
Related Link: Everything You Need to Know About Cosigning a Mortgage
The Bottom Line on Mortgage Modification Options
A mortgage modification is a practical solution for homeowners facing financial hardship. It can provide lower monthly payments without paying out of pocket for closing costs. Although it can help many burdened homeowners who do not qualify for traditional refinance options, not everyone will qualify.
A mortgage attorney can help homeowners present a stronger case and receive a more favorable loan modification. Consumers should expect some impact on their credit score, but some lenders will negotiate to minimize this impact.
Find out more about how Mares Mortgage can help you today! We have more than 20 years of experience in financing home ownership!