What Is a Mortgage Loan Modification?

What Is a Mortgage Loan Modification?

A mortgage loan modification is a substantial change to your home's loan terms. If you're having difficulty paying your mortgage—and can show that you can reliably cover a lower payment amount—the lender may agree to restructure your loan to avoid the costly foreclosure process.

If your lender permits mortgage modification (not all do), you'll probably have to pass a strict application process. If you qualify, you could pay significantly more for your home over time than you would have under your original loan—but the trade-off may be worth the ability to stay in your home.

Lenders use mortgage modification as a loss-prevention measure. They do not issue modifications automatically upon request, and typically require an application process that requires financial documentation comparable to what's required with a mortgage application.

Types of Loan Modifications

If you approach your mortgage servicer (the company that collects your mortgage payments) to explain your financial hardship, the servicer's representative will take the lead in discussing applicable options based on their policies and your specific circumstances. Loan modification may be one of those options (more on other options below).

Mortgage modification can take several forms, including the following, which may be applied individually or in combination at the discretion of your lender.

• Extending the loan term: Adding months or years of additional payments to your loan can mean you'll pay more over the life of the loan, but you'll receive a reduction in monthly payment amounts that can make your loan more affordable.
• Switching from an adjustable-rate to a fixed-rate mortgage: Because they reset their interest rates on a regular basis, adjustable-rate mortgages (ARMs) can lead to significant monthly payment increases over the life of the loan. Switching from an ARM to a loan with a more predictable fixed interest rate can simplify your budgeting.
• Reducing the interest rate: An interest point reduction can lower your monthly payment significantly. If your lender offers this option, your new repayment schedule may include "stepping up" the interest rate (and payment amount) at regular intervals until the end of the loan term.
• Reducing principal: In rare cases, a lender may lower the outstanding principal portion of your loan. This reduces the amount you owe and instantly increases your home equity. Note that equity acquired through loan modification is considered taxable income, and be mindful of potential changes to your tax return.

Learn more: Options if You Can't Afford Your Mortgage Payments

Loan Modification Requirements

Each lender that offers mortgage loan modification can set its own eligibility criteria, so requirements can vary from case to case. That said, the application process typically requires you to take the following steps:

• Demonstrate financial hardship. You should expect to explain why you can no longer afford your current mortgage payments and show proof of reduced household income or increased expenses, for instance.
• Meet lender-specific credit guidelines. You'll likely undergo a credit check, and the lender may require that your score meets or exceeds a minimum it sets. Because missed debt payments can hurt your credit scores, it's important to approach your lender as soon as you think you might miss a mortgage payment. Waiting until you've missed more payments could reduce your scores and lower your odds of qualifying for a mortgage modification.
• Submit thorough documentation. As with your original loan application, you'll need to show evidence of income in the form of pay stubs or tax returns, and to submit paperwork illustrating monthly expenses. You may also be required to document the value of assets such as savings and investments, all to show you'll be able to keep up with your reduced payments if you receive a loan modification.

Should I Get a Loan Modification?

Whether you should get a loan modification depends on its availability and your review of all your options. If a mortgage modification is possible and fits your needs better than other alternatives, it could help you avoid foreclosure.

If you are behind on your mortgage payments or anticipate missing an upcoming payment, get in touch with your loan company to discuss your options. Those options include mortgage modification if:

• The mortgage company offers loan modifications.

• You meet the requirements for financial hardship. Circumstances that may qualify include:

  • Chronic illness or disability
  • A spouse's death (and consequent loss of their income)
  • Divorce
  • Natural disaster or uninsured property loss
• You demonstrate to the lender's satisfaction that you'll be able to keep up with your payments if they're reduced under a mortgage modification.
• You have sufficient means to reliably pay reduced payments under a modified loan agreement.

Learn more: How Does a Loan Modification Affect Your Credit Scores?

How to Get a Loan Modification

If mortgage modification is a viable option in your case, here's what you'll likely need to do to get one:

1. Satisfy the loan company's prerequisites. Some servicers won't consider you for mortgage modification or other foreclosure-prevention measures until you've missed one or more scheduled mortgage payments.
2. Gather and submit paperwork. You'll need to show the nature of your financial hardship by documenting changes in your household income or circumstances that affect your ability to cover your current mortgage payment. You'll need to show what your income and expenses were before the hardship kicked in, and how they've changed. Having this information in hand before you reach out to your loan company will help you address questions.
3. Submit an application. The loan servicer will supply any necessary forms, guidance on whether you can submit them electronically or as hard copies, and what supporting documents must accompany the submission.
4. Make trial payments if asked. Some servicers will ask you to make a series of three to six monthly payments as part of their qualification process. Failure to pay them in full and on time could disqualify you from a loan modification.
5. Await a final decision. Your mortgage company could take several months to complete its decision on your loan modification, and will notify you of its final determination in writing.

Learn more: How Can I Get a Mortgage Modification?

Alternatives to a Loan Modification

Loan modification isn't the only option a mortgage company may offer if you're having trouble making your mortgage payments. Which options are available may depend on lender policy and your financial specifics, but the following may be on the table.

Mortgage Forbearance

If you expect your financial hardship to be temporary and can document your reasons for expecting to resume regular mortgage payments within six to 12 months, mortgage forbearance may be a good option. This lowers or suspends your mortgage payments temporarily, with the understanding that at the end of the forbearance period, you'll resume regular payments, and you'll make payments in addition to the regular ones until you've made up for the unpaid forbearance amount (and applicable interest).

Repayment Plan

If you've missed a few mortgage payments but are able to resume your regular payment schedule, a repayment plan temporarily increases your monthly payment amount until you've repaid the delinquencies (plus interest).

Refinance

If your credit is strong and prevailing market conditions allow it, you may be able to refinance your mortgage. With a refinance, you get a new loan and use it to pay off what you owe on your original loan, with a more favorable interest rate and terms that lower your monthly payments. Keep in mind that you'll likely need to pay origination fees and other closing costs on the new loan.

Short Sale

If your outstanding mortgage balance is greater than your home's market value, your lender may agree to a short sale, accepting the proceeds from the sale of the house to settle the mortgage. This can be better for your credit than foreclosure, but you'll collect nothing on the sale of your home, and may owe taxes on the portion of your loan balance that isn't covered by the sale.

Deed in Lieu of Foreclosure

If you and your lender cannot agree on a plan that allows you to remain in your home, a deed in lieu of foreclosure agreement can spare you both the expense and hassle of a legal foreclosure proceeding. If you agree to vacate your home voluntarily by an agreed-upon date, the lender may even provide you a "cash for keys" stipend that you can put toward new accommodations.

Learn more: How Many Mortgage Payments Can You Miss Before Foreclosure?

Frequently Asked Questions

The Bottom Line

A mortgage modification can be a win-win by allowing borrowers experiencing financial hardship to keep their homes, while sparing lenders the expense of a foreclosure. Qualifying for a mortgage modification can be challenging, however, and typically requires reliable income and a solid credit history. If you hope to pursue mortgage loan modification, you can understand your credit standing better by checking your Experian credit report for free.