A loan modification is exactly what it sounds like: a change in the terms of a loan. The objective: achieve a lower, manageable monthly payment.
Typically, applicants are borrowers suffering financial hardship who are in danger of stumbling from default (that is, behind in his/her payments) headlong into foreclosure.
Modification is an alternative to the messy process of foreclosure, bringing relief the homeowner (who gets to stay put) as well as the lender (which doesn’t incur the expense and time lost to foreclosure). It’s sort of a win-win, especially if the borrower is informed, organized, proactive and persistent.
What Types of Loan Modifications Are Available?
A variety of ways exist for a lender to help its distressed client find at least temporary relief. Keep in mind, not all lenders offer all the options listed here. Moreover, your lender might have additional options. It’s best to explore each from an informed position.
Incidentally, loan modifications, like loan applications themselves, are for everyone who complained they’d never use algebra in real life. Payments are the result of an algebraic formula involving three variables: principal, interest rate, and term (length of the loan). In a loan modification, applicants attempt to alter one or more of these variables to reduce their payments.
Principal reduction: We begin with the holy grail of loan modifications — eliminating a portion of your original debt and recalculating your payments based on this new figure. Because the result is a direct hit to their bottom line, lenders are reluctant to saw off a portion of the principal; they much prefer to restructure troubled loans in other ways. If you are approved for a principal reduction, however, consult with a tax professional; the forgiven portion of your loan may be subject to income taxes as regular income.
Lower interest rate: Your lender might be willing to negotiate a break on your interest rate. In some cases, a quarter or even an eighth of a point can make all the difference. This cut may be temporary, however; know the details of your modification and, if your reduction isn’t permanent, be prepared for when your rate, and payment, pop up again.
Extended term: Lenders sometimes are willing to recalculate a loan based on a longer payoff schedule. A 15-year loan can stretch to 20 or 30. Be wary, however, of lenders offering to extend loans beyond 30 years; if the plan is to lengthen your mortgage to 40 years or more, scrutinize the modification for prepayment penalties. Make sure you won’t incur a sanction if you sell the house, or recover yourself sufficiently to refinance into a shorter loan.
Refinance the loan: Modification generally is for borrowers who are in trouble on their mortgages and unable to refinance. However, under certain circumstances — the house has plenty of equity, or the borrower has untapped resources — even a problem borrower can refinance. Replacing your current loan for one with a lower interest rate, a longer term, or both, could drop your monthly payment substantially. The downside: There will be closing costs, and — assuming you stay put for the duration of the loan — you probably will incur higher total interest costs. Loan modifications, by contrast, can be completed faster and without processing fees.
Convert to a fixed-rate: If you have a variable interest-rate loan that’s been ticking toward the point of breaking your budget, you’re definitely a candidate for a fixed-rate loan.
Postpone payments: Suppose your financial bind is temporary. You’re caught between jobs (but you’re undeniably employable), you’ve encountered unanticipated medical expenses, or there’s been some other setback. If you’ve been a model mortgagor, you might be able to skip a handful of payments. Those payments are not forgiven; they’re tacked onto the end of your loan, so you’ll have to postpone your mortgage-burning party, or there will be a larger balance due when you sell your house.
While you’re at it: Look for other ways to save on your payments, especially if you are having your property taxes and insurance put into escrow.
- While county property assessors rarely make significant errors on the taxable value of typical homes, it’s never a bad idea to inspect your annual notice. A mistake in your overall value (overstating the number of bedrooms or bathrooms, or the size of your property) or the value of add-ons (a pool, or out-buildings, size of your property) could add substantially to your tax bill. Do your research, then visit your county property appraiser’s website to learn how to challenge your valuation.
- Make certain your homeowner’s insurance is right for your needs. Review your deductibles. Don’t pay for coverage you don’t need. Shop your policy; prices can fluctuate widely within the same area, depending on how companies weigh various risks.
- Review your private mortgage insurance (PMI) status. Rising property values are your friend: Homeowners often can eliminate PMI premiums if their loan balance is less than 80% of their home’s market value.