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If you're struggling to keep up with mortgage payments and are seeking ways to avoid foreclosure, a mortgage modification could offer the help you need to stay in your home.
A mortgage modification is a change to the repayment terms on your existing home loan that lowers your monthly payment. You may be able to get a mortgage modification if you can show your lender that your financial situation has changed in a way that could permanently hinder your ability to make your payments as originally agreed.
What Is a Mortgage Modification?
A mortgage modification is a significant change your lender makes to your loan terms when you are about to miss a payment or after you've missed one or more mortgage payments. Lenders use different methods to modify mortgages, but the main goal is to prevent foreclosure so you get to stay in your home and the lender avoids the expense of seizing and reselling the property.
Qualifying for a mortgage modification typically requires that you demonstrate a significant hardship. If you're looking into a mortgage modification, make sure your lender offers this option, as not all do.
Entering into a loan modification will likely have a negative effect on your credit, but it will be less severe than you'd see with a foreclosure—and you can take steps to improve your credit that will help you get back on track.
A mortgage modification will lower your monthly payments, though it may result in greater total costs for you over the lifetime of the loan. If you qualify for a mortgage modification, your payment reduction may be achieved through any of several methods, including:
- Reducing your interest rate: Cutting your interest rate by several points can lower your monthly payment significantly. Rate-reduction modifications often use a step-up approach, in which your interest rate and monthly payment amount increase periodically (typically every five years) for the remainder of the loan's lifespan.
- Extending your repayment period: Stretching out your loan repayment over a longer period of time will reduce your monthly payments. Just keep in mind that doing so may significantly increase the total amount of interest you pay over the life of the loan. If your situation changes and you're able to afford a higher payment, however, you can consider refinancing to a loan with a better rate.
- Converting from an adjustable to a fixed interest rate: If your financial hardship is related to periodic payment increases associated with an adjustable-rate mortgage (ARM), the lender may opt to convert you to a fixed-rate loan that's more predictable and manageable.
- Principal reduction: In extremely rare instances, the lender may lower the principal portion of your loan, effectively handing you a chunk of equity in your house. If you're given that type of modification, consult your tax advisor, because the equity you receive may be considered taxable income.
- Refinancing: Strictly speaking, a mortgage refinance is not a modification because it generates a new loan agreement, rather than adjusting your existing one. It's seldom a viable alternative for modification candidates because qualifying for a new loan could be difficult. But lenders may occasionally suggest this course for borrowers who have significant assets they can use in a pinch to cover the loan (or that the lender can place a lien against in case of default on the new loan).
Who Can Get a Mortgage Loan Modification?
Eligibility requirements for mortgage modifications vary from lender to lender, but you typically must:
- Be at least one regular mortgage payment behind or show that missing a payment is imminent.
- Provide evidence of significant financial hardship, for reasons such as:
- Long-term illness or disability
- Death of a family member (and loss of their income)
- Natural or declared disaster
- Uninsured loss of property
- Sudden increase in housing costs, including hikes in property taxes or homeowner association fees
How to Get a Mortgage Modification
If you've missed one or more mortgage payments or, better yet, know you're about to miss a payment but haven't yet gone delinquent, contact your lender (or the servicer that collects your payments) and explain the reasons for your difficulty making payments.
Be prepared to discuss your financial difficulties in some detail. You'll have to document your hardship (for example, loss of income, disability or death of a spouse) as part of a formal application, so gather relevant paperwork before you call so you'll be prepared to answer questions.
The lender will likely require you to apply for the modification in writing, and to submit proof of income and expenses before and after the onset of your hardship. That could include tax returns, pay stubs, monthly bills and statements, plus information on your savings and any assets you may have (investment accounts, real estate and the like).
If your mortgage is backed by any number of federal agencies or programs, you may qualify for a government mortgage modification plan:
- Fannie Mae and Freddie Mac, the federally backed agencies that hold more than 95% of U.S. single-family mortgage loans, share a program called Flex Modification, which allows adjustment of mortgage terms in response to a wide range of financial hardships. Qualifying mortgages must be at least one year old, and applicants must be delinquent on their payments or facing foreclosure.
- First-time homeowners with mortgages backed by the Federal Housing Administration, known as FHA loans, may be eligible for a variety of relief programs. These include loan forbearance—suspension or reduction of payments for a fixed number of months, after which the excused payments must be repaid—and mortgage modification. Borrowers with FHA loans may also qualify for partial claim loans from the Department of Housing and Urban Development, which can be used for forbearance repayment and do not come due until after the original FHA mortgage is paid off or the property is sold. As with other government-backed mortgage programs, homeowners should seek information on FHA programs from the lenders that issued their loans.
- Active and retired servicemembers and surviving spouses with mortgages backed by the U.S. Department of Veterans Affairs (VA) can apply for loan modification programs and a variety of other programs designed to help avoid foreclosure. The VA advises homeowners to consult their lenders about relevant options, and to consult a federal housing counselor for guidance.
- The Coronavirus Aid, Relief and Economic Security (CARES) Act, signed into law in late March 2020 in response to the COVID-19 pandemic, offers a wide range of additional relief options for borrowers with federally backed mortgages, including mortgage forbearance for up to 12 months, followed by mortgage modifications if needed. The scope of those potential modifications, and criteria for qualifying for them, are a work in progress in light of the law's recent enactment. Homeowners should contact their mortgage servicer (the company that collects their mortgage payments) for information on assistance under the CARES Act.
While the CARES Act only covers federally backed mortgages, private lenders may be extending comparable relief programs to their borrowers.
How Does a Mortgage Loan Modification Affect Your Credit?
Lenders may report your loan modification to the national credit bureaus, and its appearance on your credit report could adversely affect your credit score. The long-term impact of a mortgage modification typically will be less severe and long-lasting than the damage done by foreclosure.
In the case of mortgage modification programs that require you to be delinquent on your payments to qualify, your credit report will reflect missed payments in addition to the modification itself. Depending on your credit history and the credit score you had before those missed payment(s), your first delinquency could cause a greater drop in credit score than a subsequent mortgage modification would.
If a mortgage modification works as intended and allows you to stay in your house and resume regular on-time mortgage payments, you will be well positioned to rebuild your credit and restore your credit score within a few years—a much better prospect than having a foreclosure on your credit report for seven years from the date of the first delinquency that led to it. (Credit scores can recover significantly within the seven years following foreclosure, but many lenders view a foreclosure on your credit report as grounds for declining a loan application.)
Alternatives to Mortgage Modification
If you do not qualify for mortgage modification, ask your lender about other options they may offer to help you avoid foreclosure. Potential options include:
- Repayment plans: If you've missed a few mortgage payments but are able to resume regular payments, a repayment plan can temporarily increase your monthly payments until you've repaid the amount you missed (plus interest), after which your payments will return to the normal amount.
- Mortgage forbearance: A forbearance plan suspends or reduces your payments for up to 12 months, after which you must resume regular payments and repay the payments excused during the forbearance period. Forbearance programs are designed for borrowers with temporary financial challenges.
- Refinancing: If you have good credit and interest rates are more favorable than they were when you got your original mortgage, it may be possible to refinance your mortgage—that is, replace your original loan with a new one with more affordable payments.
The Bottom Line
Mortgage modification can be a major benefit to families facing income loss. If your financial outlook has taken a downturn and you're worried about losing your home to foreclosure, reach out to your lender now to see how they can help. While your credit may take a hit in the process, you'll come out in better shape in the long term—both financially and emotionally—if you avoid foreclosure and stay in your home.