What is a mortgage loan modification?

What is a loan modification?

A loan modification is a change in a borrower’s original mortgage terms that reduces the monthly payment. A lender might offer a loan modification as part of a loss mitigation strategy if the borrower is having difficulty making monthly payments. The lender and borrower might agree to modify the mortgage by reducing the interest rate, extending the loan term, changing from an adjustable rate to a fixed rate or lowering the principal amount.

A loan modification is different from a mortgage refinance; a modification doesn’t pay off your current mortgage and replace it with a new one like refinancing does. To get a loan modification, you can only work with your current lender or servicer, and you have to be in danger of defaulting on your loan. Those who refinance are generally not at risk of foreclosure and can work with any lender.

How does loan modification work?

The goal of a loan modification is to lower your monthly payments and help you avoid foreclosure. There are several ways a loan modification can accomplish this.

A loan modification might include a three-month trial period in which you demonstrate you can make the new monthly payment.

Your lender might agree to reduce your interest rate or trade your adjustable rate for a fixed rate. A fixed, lower rate means your payments will be lower and won’t change for the remainder of the loan term, which can help you budget your mortgage payments more effectively.

Another way to lower your monthly payment is to extend the loan term. Adding years to your term reduces your monthly payment but requires you to pay more interest over the life of the loan, which increases the loan's total cost.

It’s also possible your lender will offer principal forbearance — though most of the time, lenders won’t use this option unless it’s a last resort to avoid foreclosure.

Principal forbearance is when your lender agrees to defer a portion of your principal to be paid back at a later time. This lowers your current principal amount, which in turn reduces your mortgage payment.

Loan modification types

There are generally two types of loan modifications: standard and streamline. A standard modification requires financial documentation, like bank statements or pay stubs, along with a hardship letter. The underwriter will use this information to determine your eligibility.

A streamline modification does not require this financial documentation. However, there may be other requirements to qualify — for instance, a borrower may have to be delinquent by 90 days or more on their mortgage. Though these modifications require less paperwork, a borrower's chances of redefaulting on a streamline modification tend to be higher, according to Urban Institute.

There are a number of modification programs available, depending on the lender and the type of mortgage you have (conventional or government-backed).

If you have a conventional mortgage, you can ask your lender or servicer about the Fannie Mae and Freddie Mac Flex Modification programs. These programs allow borrowers to extend their loan terms to 40 years (from the typical term of 30 years). The principal and interest payments may be reduced by 20%.

Government-backed loans (FHA, VA and USDA loans) have their own programs to help borrowers avoid foreclosure. For instance, the FHA loan modification program can lower the borrower’s monthly payment with a stand-alone modification that extends the loan term, a stand-alone partial claim or a combination of both.

Who qualifies for mortgage loan modification?

To qualify for a loan modification, you have to be in default (have already missed payments) or on the edge of default. This is why it’s critically important that you contact your lender when your financial situation changes.

The lender can help assess your situation to see if you qualify for a loan modification. If you continue to skip payments, your lender may begin foreclosure proceedings, which can ultimately lead to you losing your home.

The main qualification for a loan modification is evidence of hardship, like a disability, job loss, new medical condition or loss of a spouse. One reviewer from Utah on our site said about their decision to get a loan modification from Flagstar Bank following job loss and medical issues: “I chose to go with this route due to my family's financial position and what would work best to allow us to get a plan of action together and get going again before getting back to paying our mortgage."

Who doesn't qualify?

“Modifications get turned down when a borrower can't afford the payment, even though it's lower than the previous option,” said Sundance Brennan, vice president of sales at Nada Loans. “The thought process here is that the lender would rather not prolong the issue. If the modification is likely to only prolong the issue another six to 12 months, it's better to talk about an exit strategy like selling the home, even if that involves a short sale.”

How to get a loan modification

As a general rule, the first step is to call your lender (or the company that services your loan on behalf of the lender). It can explain the process, which should begin with a written explanation of your situation (called a hardship letter or statement).

Before you start the process with your lender, consider contacting a real estate attorney. According to David Reischer, an attorney and the CEO of LegalAdvice.com, “A consumer will be more likely to negotiate a loan modification if they contact a reputable foreclosure defense attorney. Foreclosure defense attorneys are in the best position to review the original loan documents and work with the lender.”

A real estate attorney can help you effectively negotiate a loan modification to get the terms you need.

There is always the possibility of being denied. Generally, this happens when the lender determines your current financial situation may continue for a while and you may not be able to afford even reduced monthly payments.

If you’re denied a loan modification, you do still have some options. First, you can file an appeal with your loan servicer, but you must send it within 14 days of receiving the initial loan modification decision. The servicer is obligated to assign the review to an individual who wasn’t involved in the decision and give you a written response within 30 days, according to the Consumer Financial Protection Bureau.

It’s possible to be denied for a particular loan modification program but to be eligible for a different one. If your appeal is accepted — or your appeal is denied but you have another modification offer — you have 14 days from the appeal decision date to accept the offer.

As with any financial agreement, you’ll want to carefully read over the loan modification offer before you agree and sign. Pay close attention to what parts of your mortgage are changing. It’s also important to know how the modification will affect your credit (some programs are considered debt settlement, which lowers your credit score). Be sure to ask your lender how it reports the modification to the credit bureaus.

Bottom line

A loan modification can help you avoid foreclosure and stay in your current home by changing the terms of your loan to make the monthly payment more affordable. You might seek a loan modification if you’ve experienced a hardship — like a job loss or illness — and can’t keep up with monthly payments.

The qualifications and process for a loan modification vary by lender and loan type; reach out to your lender to get more details, and be sure to consider other possible options, like forbearance or refinancing.