Borrower beware: A mortgage modification will crush your credit score

President Obama's Making Home Affordable mortgage modification plan is getting quite a bit of press lately, most of it focusing on how it can help borrowers who are having trouble with their payments.

But here's one downside to having your mortgage modified: Even if you haven't missed a payment or defaulted, lenders will report the modification to the credit bureaus and the result can be a sharply reduced FICO score. That can lead to higher interest rates on credit cards and reduced credit limits.

For most borrowers though, the benefits of the loan modification will save them enough money that the temporary FICO score beat down is a worthwhile trade-off. But the concern here is that no one -- not the government and not the banks -- is stepping up to make sure that consumers are aware of the credit score ramifications of a mortgage modification.

Bloomberg reports that Victor Stern, a North Carolina home owner, saw his credit score drop 121 points after he got bank approval for a mortgage modification. That led the limit on his credit card to be slashed from $15,000 to $500 -- a card that he needed for his business.

The takeaway for struggling homeowners is to look carefully at your need for additional credit before agreeing to a mortgage modification. If you have borrowing needs on the horizon, it may be better to keep making your current payments (if you can afford them) or sell the house (if you have any equity). However a short sale or foreclosure will likely hurt your credit score worse than a modification -- so you really may not have a better option.
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