Loan Modifications – Are They Ever a Good Idea?
If you find yourself behind on your mortgage payments, a loan modification can look attractive. Indeed, there can be a lot to like, but while it may look like your lender is throwing you a lifesaver, a modification may actually turn out to be an anchor. That doesn’t mean you shouldn’t take a loan modification, though. We’re just emphasizing that you should consider all of the angles before taking the plunge.
Before we even discuss what a loan modification actually is, the first thing you need to understand is that the lender is going to come out on top. Always. That’s just the way things are, and why they’re that way will become more apparent as we continue. Think of your lender as a casino that wants your money. You want to win, obviously, but odds are, if you aren’t careful, you’re going to lose.
This is important: a loan modification is NOT a refinance. When you refinance, you do so because you have good credit and you want to leverage that good credit towards getting a better interest rate. A loan modification, on the other hand, is a permanent restructuring of the mortgage where one or more of the terms of a borrower’s loan are changed to provide a more affordable payment. With a loan modification, the lender may agree to do one of more of the following to reduce your monthly payment: reduce the interest rate, convert from a variable interest rate to a fixed interest rate, or extend the length of the term of the loan.
As a general rule, people tend to modify their loan when their credit is bad enough that they can’t refinance the loan. In this case, the lender changes the terms on the current loan so the borrower can get back on their feet and continue paying it off.
If that sounds confusing, it’s because it is. Unfortunately, it’s that way almost by design. Loan modifications are confusing in part because of the abundance of legalese in the paperwork, and therefore it’s easy to agree to something you don’t realize you’re agreeing to.
So the next point we want to emphasize here is that if you find yourself in a situation where you need to modify your loan, pay attention every single step of the way. The lender tends to come out on top precisely because the assumption is that borrowers in dire financial straits generally haven’t the resources to hire an attorney or are desperate enough to lean on the expertise they almost certainly don’t have in order to carry them through the process.
If you have to modify your loan, seek some outside professional help if at all possible. Do NOT rely on the lender to navigate you through a process that’s already heavily weighted in their favor.
Banks actually tend to prefer this method as an alternative to foreclosure because they lose more money under a foreclosure. As for you, the borrower, a mortgage modification can help you under the right circumstances. However, you will want to make sure that you are getting the best deal before agreeing to anything.
The best part about mortgage modification is that it can help you stay on your feet, especially when an unexpected hardship comes along. Mortgage modification is designed as an alternative to foreclosing on a house or filing bankruptcy. Remember, a bank would prefer to salvage the loan than foreclose, so you do have some leverage here. Don’t get too cocky, though. If you have to foreclose on your house, it will hurt your credit badly. You might not be able to buy another house for years. Therefore, anything you can do to get out of foreclosure is a good thing.
This is where modification comes in. It can help you by lowering your interest rate, lowering your payment, or getting rid of late payments for you. If you’re behind on your payments, it can seem very overwhelming. If the mortgage lender is helpful, it can be a great asset to you and your financial situation.
It’s not all wine and roses, though. There are some downsides. Generally speaking, if you can leave your mortgage alone and avoid modification you’ll usually be better off. A mortgage modification will almost always negatively affect your credit. Just like any other loan, anytime you fail to pay off a loan like you agreed to, it can (and probably will) be reported to the credit bureaus. If a house is close to foreclosure that means you’ll probably have had quite a few late fees and missed payments leading up to your current situation. Therefore, your credit score is almost certainly going to be negatively affected from the mortgage modification process.
Further, we’d be remiss if we didn’t mention that sometimes a mortgage modification could be a huge mistake. The mortgage lenders may just be in it to help themselves out. At the end of the day, they don’t have much financial reason to care about you, and that’s worth remembering on your end. If you suspect any sort of shadiness, just stay away from their offers and stick with your loan.
One such example is in the area of blind loan modification. Blind loan modification is when the bank sends you an automated offer that is designed to get you to modify your loan. It will come with some seemingly attractive terms that entice you to accept the offer. However, when it comes down to it, the offer nearly always not in your best interest. Rather, it tends to be designed to help the bank’s bottom line in the long run and make them more money.
The bad thing about blind loan modification is that the offer is generated by a computer instead of by a person. It’s not a special offer that was designed on your behalf, with your unique situation in mind. It’s decidedly impersonal, in fact. The bank will not even be able to discuss it with you in detail. They just want you to accept the offer and start making your payments. When it comes to these types of deals, make sure that you understand what you are agreeing to.
Truly beneficial loan modification approvals are rare, but they do exist. Many mortgage lenders follow federal government guidelines (called HAMP, for Home Affordable Modification Program) when considering whether to modify a loan in order for the lender to receive incentive payments from the government.
The federal guideline is that your loan payment should be less than 33% of your income. The lender’s first option is to adjust the interest rate to lower your payment. The second step is to adjust the term of the loan, so that you pay a smaller amount for a longer period of time. If neither of these gets the payment low enough, the lender would need to forgive a portion of the loan.
This sounds good on the surface for homeowners who have lost their jobs or other source of income. They apply, thinking the bank will reduce their monthly payment to something more manageable. The problem is that banks aren’t actually required to do any of these things for the borrower. They’re obligated by law to review your application for a loan modification, but they don’t have to accept it. This is an important distinction to make.
Principal forgiveness, which is the best kind of loan modification, is actually pretty rare. Typically, you’ll be given a temporary loan modification with a lower payment, while they determine whether to offer you a permanent loan modification. This process can take up a lot of valuable time.
And now we arrive at our final, and most important point: applying for a loan modification doesn’t necessarily stop the foreclosure process. When a representative from your mortgage lender talks to you about applying for a loan modification, that doesn’t mean they aren’t continuing to pursue foreclosure. Even though it can sound that way to a homeowner, rest assured they are still thinking in terms of foreclosure or short sales. Keep in mind that the clock keeps ticking while the loan modification is being reviewed.
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