What Is Loss Mitigation?

Understanding loss mitigation

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,” said Hamilton.

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.

The benefits of loss mitigation for buyers:

• 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.
• It provides some flexibility on your monthly payments.

The benefits of loss mitigation for lenders:

• The bank saves 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

Likely the first thing your lender will offer when you’re unable to make your mortgage payment is to modify your loan. Loan modification is a relatively straightforward process that changes the terms of your loan, hopefully making it easier for you to pay it each month.

Modification 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 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,” 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. Generally, forbearance periods last between three and six months, though you can apply for an extension in extreme circumstances.

The obvious benefit of forbearance is complete relief from paying your monthly mortgage. But, Croak explained that “deferrals stretch out the loan and tack on interest, often adding tens of thousands of dollars to total repayment.”

As long as you follow through with the agreed-upon payment terms, your credit score can sometimes remain unaffected. 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.

Ask how the forbearance will be reported

Lenders don’t all treat forbearance the same way, and your credit score can take a hit. Before agreeing to a plan, ask how forbearance will appear on your credit report.

It’s important to note that 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. It’s important to note that repayment plans don’t change the terms of the loan overall; they simply provide a short-term plan to pay back overdue amounts.

Repayment plans are credit-friendliest

Of the three most common loss mitigation options, repayment plans typically have the least negative impact on your credit score 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

» FIND OUT: Is mortgage refinancing a better option?

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 leads to a better chance of avoiding foreclosure.

Hamilton shares this step-by-step look at the loss mitigation process:

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

Impact of loss mitigation on credit and finances

One of the biggest considerations for entering into a loss mitigation agreement with your lender is the hit to 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,’” Croak said, “which algorithmically downgrades a borrower’s profile. Scores may drop 50 to 100 points during the first 90 days of the workout even if no payment was missed.”

What’s more, 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.

Know how you’ll repay when loss mitigation ends

Forbearance delays payments, and modifications extend them — but neither one erases what you owe. Expect higher costs later, and plan how to cover them.

Consider this scenario from Croak, which shows how much more you could pay in the long run if you modify or defer your mortgage: A standard 12-month forbearance at a 6.75% mortgage rate could grow a $2,200 monthly payment into a balloon of $26,400, plus compounding interest.

» MORE: What to do if you’re about to lose your home

Special considerations for natural disasters

Post-disaster options depend on the lender and type of loan you have, but most offer a loan modification option in the event a natural disaster affects your home or your finances. “FHA and VA loans often have carve-outs for natural disasters,” Croak said, “and some servicers will pause payments for 90 to 180 days with zero penalties.

“But be warned: those paused payments still stack up! You will need to catch up fast or spread it out through a restructured loan. So plan on paper, not just in panic mode,” Croak advised.