A loan modification is a change to your current home loan, whether it’s a change in the repayment term, interest rate, or other terms.
How Do Loan Modifications Work?
Loan modifications are available for borrowers who are facing severe financial hardships. Many lenders prefer to work with you on a compromise rather than resorting to foreclosure proceedings.
To get a loan modification, you must prove financial hardship. Loan modifications can take months to complete. Alternatives to loan modifications include temporary forbearance and refinancing.
How to Obtain a Loan Modification
Start by contacting your lender by phone or inquiring online. Be honest and explain why it’s difficult for you to make your loan payments right now. Then, tell the lender about the proposed loan modification.
Lenders often require a loss mitigation application and details about your financial situation to assess your request. Some may require you to be behind on a loan payment, often up to 60 days. Be prepared to provide:
- Income: This is the amount you earn and its source.
- Expenses: This is the amount you spend monthly and how much goes to different categories like housing, food, and transportation.
- Documentation: You may often need to provide proof of your financial situation, including pay stubs, bank statements, tax returns, and loan statements.
- Hardship letter: Explain what has happened that affects your ability to repay your current loan installments and how you hope to rectify the situation or how you have done so. Other documentation should support this information.
- IRS Form 4506-T: This form allows the lender to access your tax information from the Internal Revenue Service (IRS) if you cannot or do not provide it yourself.
The application process can take hours. You’ll need to fill out forms, gather information, and submit everything in the format requested by the lender.
Within 30 days of receiving a completed application, the lender typically must respond to your request with a written notice of its offer or denial, specifying the terms of the loan modification. Stay in touch with your lender during this time in case any questions arise. It is usually best to do what the bank says during this time, if at all possible. For example, you may be asked to continue making payments. Doing so can help you qualify for a loan modification. In fact, this is a condition for approval with some lenders.
Once you receive an offer for a loan modification, you will need to accept or decline it within the specified timeframe to see changes to your loan.
Please note that a loan modification and temporary forbearance are not the same thing. Temporary forbearance suspends payments temporarily for a specified period under the current loan terms. It is a short-term adjustment but does not affect the overall loan. Once the forbearance ends, you will be expected to make up the missed payments plus any accrued interest. A loan modification makes permanent changes to the current loan.
The Advantages and Disadvantages of Loan Modifications
Advantages
- Lower interest rate: A loan modification can lower your interest rate, reducing your monthly payment and decreasing the amount of interest you pay over the life of the loan.
- Change in loan type: You can switch from an adjustable-rate mortgage to a fixed-rate mortgage. This means your interest rate could change.
- Longer repayment period: Regular loan terms typically extend up to 30 years. However, you can extend your repayment period, which reduces your monthly payment to something more affordable.
Disadvantages
- Short-term difficulty: Because loan modifications can take months to arrange, you may fall further behind on your mortgage with each passing month. You may also incur costs, such as the cost of an appraiser, while working through the process.
- Increases
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Interest costs: If you extend your loan terms, you may end up paying more interest over the life of the loan.
Loan Modifications vs. Refinancing
Refinancing and loan modification may seem similar, but they are not the same thing.
| Loan Modification | Refinancing |
|---|---|
| Changes your current loan | Replaces your old loan with a new one |
| Can lower your interest rate, monthly payment, or both | Can lower your interest rate, monthly payment, or both |
| Works with the current lender | Works with a new or current lender |
| Must show financial hardship, and may have been late on payments for several months | Can refinance at any time, but you must pay closing costs again |
| Cannot withdraw cash | Can withdraw cash |
| No prepayment penalty | Prepayment penalty |
| Cannot extend the loan term | Can extend the loan term |
Alternatives to Loan Modification
Loan Refinancing
Modification is typically an option for borrowers who cannot refinance their loan, but it may be possible to replace the current loan with a new one. This is a particularly good option if you want to access cash from the equity that has built up in your home.
The new loan may have a lower interest rate and a longer repayment term, so the result will be the same – you will have lower payments in the future. You may have to pay application and setup fees on the new loan. You also need to have good credit.
Bankruptcy
If you cannot get a loan modification or refinance your loan, you may have one other option to keep your property. You can file for bankruptcy under Chapter 13. This is not the same as Chapter 7, where the court takes control of any non-exempt assets, if any, and liquidates them to pay your creditors. Chapter 13 allows you to enter into a court-approved repayment plan to pay off your debts, typically over three to five years.
You can include your loan arrears in this if you qualify. It allows you to catch up on things and get back on track, as well as keep your home. You will usually have to continue making your current loan payments during the transition period. If this seems impossible, explore if you can consolidate your other debts into the repayment plan as well. You must have enough income to qualify.
Frequently Asked Questions
Can you refinance after a loan modification?
You can refinance a mortgage after a loan modification, although your lender may require you to wait a certain period before doing so. Most importantly, the financial circumstances that led you to request a loan modification may have negatively impacted your credit score or debt-to-income ratio, or other factors, making it less likely that you would qualify for refinancing.
How long does a loan modification take?
A loan modification is a permanent change to your loan terms and will last as long as you own the home or are repaying the loan through payments. The application process can take a long time and includes a trial period during which you must make timely payments to demonstrate that the new terms are affordable for you.
Source: https://www.thebalancemoney.com/loan-modifications-315514
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