Loan Modifications: What You Need to Know

Loan modificationLast year was difficult for Adline Peck and her husband. Peck, who lives in Inkster, Mich. was battling medical issues, and her husband had been laid off from work. Though they struggled to make their monthly mortgage payments, they continued to try their best, even if it meant sending in payments a week or two late. Eventually, Peck approached a friend in real estate who proposed a solution for their financial hardships: A home loan modification.

"The three of us got together, and we found the best package there is," Peck said of her loan modification. "It was not the headache I thought it was going to be."

The Pecks' loan modification enabled them to keep up with their payments and, more important, to keep their home. If you're seeking a loan modification, here's how to start:

What to Know When Considering Loan Modification

A loan modification is a potential solution for homeowners like the Pecks, who have encountered financial hardships and want to change the terms of their loan. The goal is to lower the monthly payments to a level that the homeowner can afford, whether through
  1. a reduction in the principal balance,
  2. a reduction of the interest rate,
  3. or an extension of the loan term.
"In short, a homeowner can save thousands if not millions of dollars in the course of the rest of the life of their loan," says Alessandra Marx, of NSS Financial Services.

Before starting down the road of a loan modification, there are important things to know:

A reduction in the principal balance is rare, says Joshua Talayka, a Realtor in Reno, Nev., with Chase International Real Estate. "There have been a few stories out there where a lender has done this, but they are few and far between, and typically the result of extraordinary circumstances," he says.

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Then there's an effect of the loan modification on the borrower's credit score. While loan officers may assure homeowners considering loan modifications that doing so will have no impact on credit scores, there is evidence that says otherwise.

And a modification won't reverse the effects that missed payments have already had. Talayka advises homeowners considering a loan modification to meet with an attorney and a tax professional to see what other penalties might accompany their decision.

Homeowners should expect their loan servicer to explore other options before deciding to go with a loan modification. "The simplest option is called a temporary forbearance, where a borrower is allowed to skip a few payments when there is a temporary loss of income and allowed to make the overdue payments in a lump sum when their income is restored," says Souren Sarkar, executive vice president of ISGN.

"Alternatively, a portion of the overdue payments are added or capitalized into the monthly payments, resulting in a small increase in the monthly payment amount until the overdue amount is paid off."

If the loss of income experienced by the homeowner is permanent, then a loan modification is the next step. Lenders will first see if the borrower is eligible for the federal Home Affordable Modification Program (HAMP) or state programs; if that doesn't work, says Talayka, they'll see if they can work out an in-house modification.

The Loan Modification Process

The first step of the loan modification process requires the homeowner to submit a "hardship letter" detailing their financial difficulties. The hardship must be significant -- unemployment, reduction in income, a death in the family, etc.

Homeowners will also need to fill out a financial information worksheet, which itemizes their income and expenses, and to submit supporting documents, including bank statements and tax returns.

The lender then runs an analysis of the borrower's situation and approves or rejects the application for a loan modification. "However, the decision of the servicer is negotiable, and the borrower is well-advised to appeal the servicer's decision if they don't get an optimal response, providing additional documentation as needed to plead their case," says Sarkar.

It's essential for homeowners seeking a loan modification to follow up, and to do so often throughout the process to make sure documentation has been received.

Homeowners on the verge of being approved for a loan modification might be put through a trial repayment period at the new payment amount. During this stage, borrowers have to show they have the capacity to make these payments. "A lot of effort is expended by some programs to make sure 'bad actors' don't get through, or to prove beyond a shadow of doubt the borrower's ability to pay," says Steve Home, president of Wingspan Portfolio Advisors.

Two Loan Modification Caveats

Though getting a home loan during the peak of the housing market might have taken just a few weeks, securing a loan modification today might take months of agonizing back-and-forths with lenders. That's why it's essential for homeowners seeking a loan modification to follow up, and to do so often throughout the process to make sure documentation has been received.

Homeowners should also be wary of scams that promise loan modifications in exchange for upfront fees, a practice that the government has banned.

Peck's two pointers for homeowners thinking about getting a home loan modification are:
  • seek guidance from somebody who is knowledgeable about mortgages.
  • keep communication going with the servicing company throughout the process.

She was fortunate to avoid the potential pitfalls that come along with loan modifications and found herself with new loan terms that enabled her and her husband to make their monthly payments and keep their home. "It was like 'snap snap' -- when something goes so quick like it never happened." Peck says that if everyone knew companies like the one she worked with, "there would be no mortgage problems at all."

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