Loan modification occurs when a lender agrees to change the terms of a homeowner’s mortgage to help them avoid default and keep their home in times of financial hardship.

The purpose of a home loan modification is to reduce the borrower’s payments so that he can repay the loan every month. This is usually done by lowering the mortgage rate or extending the repayment term of the loan.

“A home loan modification does not replace your existing home loan or lender,” says Karen Condor, a finance and insurance expert

How Home Loan Modification Works

With a loan modification, the total amount of the principal due will not change.

“But the lender can accept a lower interest rate, a shorter loan term, or a longer repayment period,” says Elizabeth Whitman, a lawyer and executive member of Whitman Legal Solutions, LLC.

Either of these strategies could help reduce your monthly mortgage payments and/or the total amount of interest to be paid in the long term.

The change could also include switching from an adjustable-rate mortgage to a fixed-rate mortgage and adding overdue fees to your principal, Condor adds.

Keep in mind that the loan modification is aimed at lowering the mortgage month by month. But it often involves extending the term of the loan or adding late payments to the loan, which can increase the total amount of interest paid.

Refinancing a new loan, on the other hand, often reduces the monthly payment and the total cost of interest.

Loan Modification vs. refinancing

A refinance is often the first action plan for homeowners who need a lower mortgage payment.

Refinancing may replace the original loan with a new one with a lower interest rate and/or a longer term. This can offer a permanent reduction in your home loan payments without adversely affecting your credit.

However, troubled borrowers may not be able to refinance.

They may have trouble qualifying for the new loan due to low income, a lower credit score, or unexpected debts (such as medical bills).

In these cases, the homeowner is eligible for a home loan modification.

The loan modification is generally reserved for homeowners who are not eligible for refinancing due to financial difficulties.

Mortgage modification is generally reserved for borrowers who do not meet the requirements for refinancing and have been left with no other possible mortgage relief options.

“With a loan modification, you work with your existing bank or lender to change the terms of your existing mortgage,” explains David Merritt, consumer finance attorney Bern Kopf

Goodman, LLP.

“If you default on your current mortgage, your credit is likely to be adversely affected until a new lender is careful to give you a new loan.”

There is no real competition between a loan modification and refinancing. The right choice for you will depend on the status of your current loan, your finances, and how much your mortgage lender will accept.

Loan Modification vs. forbearance

Forbearance is another way in which managers can help borrowers in times of financial stress.

A loan grant is a temporary plan that stops mortgage payments while the homeowner recovers.

For example, many homeowners who lost their jobs or had a low income could apply for a grant of up to a year or more during the COVID pandemic.

Unlike forbearance, home loan modification is a permanent plan that changes the rate or terms of a home loan.

Sometimes forbearance and loan modification can be combined to create a more effective mortgage relief plan.

For example, a homeowner whose income is still falling at the end of the grace period may be allowed to change the permanent loan.

Alternatively, a homeowner approved for a mortgage modification can have some of the unpaid principal transferred (deferred) until the end of the payment period.

Who is entitled to the loan modification?

To qualify for a loan modification, borrowers typically must have lost at least 3 mortgage payments and are in default.

“Sometimes, borrowers who have experienced financial difficulties and are in bad debt may be eligible for a loan modification. But not everyone who defaults on their mortgage payments is entitled to a loan modification, “explains Whitman.

“Borrowers whose financial recession is so severe that they will never be able to pay their mortgage will never change” – Elizabeth Whitman, attorney and managing member of Whitman Legal Solutions, LLC

As well as providing a letter or statement of hardship, be prepared to provide proof of income, two-year tax returns, and financial / bank statements says Condor.

However, keep in mind that your lender is not required to provide a loan modification.

How to apply for a loan modification

The procedure for applying for a loan modification varies depending on who manages the loan.

The first thing you need to do is contact your loan service provider. This is the company to which you send payments and must work to determine your loan modification options.

Some mortgages are managed or “managed” by the original lender. But most mortgages are taken care of by a separate company.

For example, you may have received a loan from Wells Fargo, but you are now making payments to US Bank.

The loan service provider is the company that makes the monthly mortgage payments; you can find yours by checking your name and contact information on the latest bank statement.

Many borrowers begin the process by sending a “letter of difficulty” to the lender. A hardship letter is simply a note describing the borrower’s financial difficulties and explaining why he is unable to make the payments.

The lender will likely ask for financial information and documents, including bank statements, pay stubs, and proof of your assets.

These documents will help your lender understand all of your finances and determine the appropriate form of mortgage relief.

Home loan modification programs

Your loan modification options will depend on the type of loan you have and what your lender or loan manager accepts.

Classic loan modification

“Fannie Mae, Freddie Mac, and regular private lenders have their restraint programs and guidelines,” says Charles Gallagher, a real estate lawyer.

In particular, Freddie Mac and Fannie Mae offer Flex Modification Programs designed to reduce mortgage payment on qualifying loans by approximately 20%.

The flex modification usually involves adjusting the interest rate, avoiding part of the principal balance, or extending the loan term to make monthly payments more affordable for the homeowner.

To be eligible for a flexible modification program, the homeowner must have:

• At least 3 monthly payments due on a primary residence, second residence, or investment property
• OR; less than 3 monthly payments past due, but the loan is “imminently delinquent,” which means that the lender has determined that the loan will be permanently delinquent without modification. This is only an option for primary residences

Some difficulties can trigger the state of “imminent defect”; for example, the death of the main family worker, or the serious illness or disability of the borrower.