What Is Loss Mitigation?

How loss mitigation works

Most people think loss mitigation is code for foreclosure avoidance, said Eric Croak, president of Croak Capital, a wealth management firm. He said loss mitigation is actually a catchall for any negotiated solution with a lender when you’re behind.

“That could mean a loan modification, repayment plan or something else entirely,” Croak said. “The real issue is that people assume it’s a last resort. In reality, the earlier you act, the more options stay on the table.”

The purpose of loss mitigation is to help borrowers avoid foreclosure, said Adam Hamilton, co-founder of REI Hub, which provides accounting software to real estate investors.

“Lenders want to avoid or ‘mitigate’ the likelihood of foreclosure too,” Hamilton said. “So if their borrowers are having a hard time making their payments, they will often work with them to come up with ways to make repaying the mortgage more affordable or reasonable.”

» MORE: What happens if you miss a mortgage payment?

Advantages of loss mitigation for homeowners vs. lenders

While mortgage insurance can help protect a lender in the event of foreclosure, loss mitigation is often the easier and less costly avenue for both parties.

Benefits for homeowners

The benefits of loss mitigation for homeowners are:

• You can avoid going into foreclosure and keep your home
• You’ll suffer less of a hit to your credit score than you would in foreclosure
• You’ll get some flexibility on your monthly payments

Benefits for lenders

The benefits of loss mitigation for mortgage lenders are:

• The bank will save on court costs, legal fees and lost payments on the asset
• It keeps the borrower in the home, which is simpler and less disruptive to payments than selling or foreclosing
• The property is less likely to sit vacant, which can lead to issues like deterioration and break-ins

Common loss mitigation options

Some common loss mitigation options for homeowners struggling to make their mortgage payments include loan modification, mortgage forbearance or a repayment plan.

Loan modification

When you’re unable to make a mortgage payment, a lender will typically offer to modify your loan. Loan modification changes the terms of your loan, hopefully making it easier for you to pay it each month. This could mean extending the repayment period, recasting the mortgage, lowering the interest rate or placing the unpaid principal amount in forbearance for a specific period.

Modifying your loan is often the quickest and easiest loss mitigation option. It lowers your payment and can help you avoid foreclosure. But you’ll end up owing more later on, especially if you extend the loan.

“Loan modifications may cut the monthly bill but extend amortization, meaning a 30-year mortgage could quietly become 40 years, with more paid in total,” Eric Croak said.

Eligibility requirements for loan modification

To be eligible for a loan modification, you must:

• Demonstrate financial hardship
• Go through a trial period before the modification is approved
• Use the property as your primary residence

Forbearance

Putting your mortgage payment into forbearance means you won’t have to pay anything toward your mortgage for a set period of time. Generally, forbearance periods last between three and six months, though you can apply for an extension in extreme circumstances.

As long as you follow through with the agreed-upon payment terms, your credit score can sometimes remain unaffected. However, because reporting practices for forbearance can differ and affect how your credit report looks, it’s a good idea to confirm your lender’s policy first before agreeing to forbearance.

Once the forbearance period ends, you’ll be expected to either resume payments or pay the entire deferred amount back, depending on your lender’s requirements.

Eligibility requirements for forbearance

To be eligible for forbearance, you must:

• Maintain decent credit and good standing with your lender
• Demonstrate that your financial hardship is temporary
• Prove that you have the ability to resume payments

Repayment plan

A repayment plan can help you avoid facing a large, lump-sum payment like you might see in a forbearance. However, repayment plans don’t change the terms of the loan overall, they simply provide a short-term plan to pay back overdue amounts.

Of the three most common loss mitigation options, repayment plans typically affect your credit score the least as long as you follow the repayment schedule.

Eligibility requirements for a repayment plan

To be eligible for a repayment plan, you must:

• Maintain decent credit and good standing with your lender
• Demonstrate that your financial hardship is temporary
• Use the property as your primary residence

How to start the loss mitigation process

If you’re having a hard time paying your mortgage, it’s important to act fast. The sooner you contact your mortgage lender for loss mitigation assistance, the more options you’ll have. This can lead to a better chance of avoiding foreclosure.

Adam Hamilton said the loss mitigation process generally follows these steps:

1. First, you’ll want to directly contact your lender’s loss mitigation department.
2. Next, you’ll fill out a hardship application. You’ll enter basic information and answer questions about your financial situation.
3. You’ll likely be asked for pertinent documentation, like bank statements, tax documents and mortgage statements.
4. Your lender will then review your complete application and decide what types of mitigation plans to offer, if any.
5. If you qualify for a loss mitigation plan, you and your lender will work out the terms together.

Should you enter a loss mitigation agreement?

If you’re unable to pay your mortgage on time and in full each month, and if you’ve exhausted all of your own options in doing so, contacting your lender about loss mitigation can be a good idea. Still, keep the following in mind:

Your credit will be affected

One of the biggest considerations for entering into a loss mitigation agreement with your lender is the impact on your credit score, which will likely be affected.

“Even if the plan avoids a delinquency mark, the activity can still show as ‘modified’ or ‘in hardship,’ which algorithmically downgrades a borrower’s profile,” Eric Croak said. “Scores may drop 50 to 100 points during the first 90 days of the workout even if no payment was missed.”

You could pay a lot more

Keep in mind you could end up paying much more in fees and interest payments in the long run when you extend the life of your mortgage loan.

For example, Croak said that a standard 12-month forbearance at a 6.75% mortgage rate could grow a $2,200 monthly payment into a balloon payment of $26,400, plus compounding interest.

» MORE: When is a mortgage payment considered late?

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