A mortgage loan modification is a change in the original contract agreement in the case of a borrower being unable to repay the loan as scheduled. The result of such a modification is usually a reduction in the borrower’s monthly payment, the interest rate, or the outstanding principal on the loan in order to make repayment possible for the borrower.
A loan modification is a long-term solution for a borrower who is unable to repay their mortgage under their current conditions, but should only be used under extreme circumstances such as an imminent foreclosure or a permanent negative change to surplus income. Due to loan modifications being created as a means to help people in dire straits and not for those who are able to repay their loans, obtaining one can be difficult and affect credit scores negatively.
How Damaging a Loan Modification Can Become
The extent to which a loan modification can affect your credit score and ability to receive credit in the future depends on a number of factors—namely, the avenue through which you obtain a loan modification, the manner in which your lender reports the changes made to your loan, and the degree to which your lender and credit-score providers choose to penalize loan modifications.
What Options Do Homeowners Have?
There are a few different options for a borrower who wants to modify the existing terms of their mortgage, and each one may affect the borrower’s credit differently. Some loan repayment programs, such as government-endorsed ones like Home Affordable Modification Program (HAMP) do not report any delinquency on accounts if the borrower qualifies and the program’s requirements are met, and the borrowers credit score is not affected.
Sponsored programs like HAMP help people by lowering monthly mortgage payments and interest rates, and providing a way out for those for whom home ownership is no longer affordable or desirable without going into foreclosure. These usually begin with a three- or four-month trial period during which time delinquent status may be reported if payments are not made in full and on time. In any case, the credit report notes that the loan has been modified under a federal government plan.
If the borrower does not qualify for any government-sponsored program, approval of a loan modification by a lender is voluntary. Some lenders will only give a loan modification for a loan that is already delinquent, or if the cost of modifying your loan will be less than that of default. This usually means that the borrower’s credit score is already receiving a negative blow; credit scores are negatively affected any time a lender reports the account as anything but paid in full and on time. Once a borrower accepts a loan modification the impact that it has on their credit score is still, to some extent, at the discretion of the lender.
There are also some programs that are referred to as “loan modification programs” when they are in fact privately sponsored debt settlement or debt consolidation programs. These can hurt your credit score because they modify the original credit agreement with your lender. A debt settlement is also noted on your credit report, which could cause potential future lenders to think twice about lending to you. It is usually a better idea to try to negotiate with lenders first before considering debt settlement programs because these are not always the best long-term solutions.
The Damage To Your Credit
How a loan modification can hurt your credit score has a lot to do with the way in which your lender reports the change. In some cases the loan in simply reported as changed, and in others it’s reported as an entirely new loan. Having the terms of an existing loan changed on your credit report is much preferable to having a new one because of the impact a new open date and credit obligation has on your overall score. That being said, your credit score can be affected in either case because of the inquiry and any change to the loan balance and terms.
Nevertheless, even if the credit-reporting agencies do not penalize you significantly with a blow to your credit score itself, potential lenders—or even potential employers or landlords—can still see the loan modification on your credit report and use the information against you during the evaluation. Your credit report is a direct reflection of your past ability to adhere to repayment schedules and settle accounts, so having a loan modification on your report can make it difficult to obtain credit in the future.
When A Loan Modification Becomes Your Only Option
Of course, for some borrowers loan modification is their only remaining option. Even the negative effect that such a modification can have on one’s credit score can be better than that of foreclosure or bankruptcy. What is most important is to pay attention to the fine print when considering a loan modification; check with your lender before applying to find out how they would report the changes to your loan. What you want is for your payments on the modified schedule to appear as paid in full, rather than partially paid or on a new loan altogether. This way, even if your credit score is affected, the damage won’t be as bad.
Loan modifications last on your credit report for a long time and they can hurt your credit significantly. It is important that if you are considering changing your mortgage, do so as a last resort when you are no longer able to make the scheduled payments on time, and after you’ve spoken with a mortgage specialist.