What Is a Mortgage Loan Modification?

How does loan modification work?

A loan modification is a change in a borrower’s original mortgage terms that reduces the monthly payment. A mortgage lender might offer a loan modification as a 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 might include a three-month trial period in which you demonstrate you can make the new monthly payment.

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.

Rate adjustments

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.

Extended loan term

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.

Principal forbearance

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

» MORE: How to lower your monthly mortgage payment

Types of loan modifications

There are generally two types of loan modifications: standard and streamline. However, there are more modification programs available, depending on the lender and the type of mortgage you have, like a conventional loan or a government-backed loan.

Standard loan modifications

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.

Streamline loan modifications

A streamline modification doesn’t require providing 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.

Conventional loan modifications

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 from 30 years to 40 years. The principal and interest payments may be reduced by 20%.

Government-backed loan modifications

Government-backed loans, like Federal Housing Administration (FHA), Veterans Affairs (VA) and U.S. Department of Agriculture (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 a loan modification?

To qualify for a loan modification, you have to be in default, meaning you’ve already missed payments, or on the edge of default. This is why you should contact your lender as soon as possible when your financial situation changes.

Your 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.

Who doesn’t qualify for a loan modification?

A borrower usually won’t qualify for a loan modification if they can’t afford an adjusted loan payment.

“Modifications get turned down when a borrower can’t afford the payment, even though it’s lower than the previous option,” said Sundance Brennan, head of revenue at Nada, an investment platform.

“The thought process here is that the lender would rather not prolong the issue,” Brennan said. “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

Generally, the first step is to call your lender or the company that services your loan on behalf of the lender. Your lender can explain the process and help you write a hardship letter or statement, which is a written explanation of your situation.

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

Before you start the process with your lender, consider contacting a real estate attorney.

“A consumer will be more likely to negotiate a loan modification if they contact a reputable foreclosure defense attorney,” said David Reischer, an attorney based in New York. “Foreclosure defense attorneys are in the best position to review the original loan documents and work with the lender.”

As with any financial agreement, you’ll want to carefully read over a loan modification offer before you agree and sign. Pay close attention to what parts of your mortgage are changing and ask your lender how it reports the modification to the credit bureaus.

What happens if you’re denied for a loan modification?

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’ll 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 (CFPB).

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

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. Start by reaching out to your lender to get more details, and be sure to consider other possible options, like forbearance or refinancing.