Definition and Examples of a Loan Modification
A loan modification restructures your current home loan. This could be:
- Changing the loan type
- Extending repayment terms
- Altering the interest rate
- Reducing the total principal balance
If you can’t afford your current payments or you’ve already fallen behind, a loan modification can help you get back on track by reducing the interest rate, the total amount owed, or your monthly payments.
Keep in mind that a loan modification and forbearance are not the same. Forbearance is temporarily pausing repayment for a fixed amount of time on your current loan terms. It’s a short-term adjustment but doesn’t impact the overall loan. After forbearance ends, you will be expected to make up the missed payments along with any accrued interest. A loan modification makes permanent changes to the current loan.
How Do Loan Modifications Work?
To get started, you’ll need to gather information and documents about your loan and your current financial situation:
- Mortgage statements
- Other types of debt, such as credit cards, student loans, or car loans
- Other bills, such as utility bills, alimony, child support, and other recurring payments
- Your income, including recent pay stubs and tax returns
Next, determine the current value of your home. You can look for an estimate of the current market value on a real estate valuation website, or contact a real estate agent or appraiser. Agents and appraisers may charge you a fee for the service.
After you’ve collected the paperwork and determined your home’s value, contact your lender. This is the company you pay every month. Take notes during your call, including when you called, whom you spoke to, and the details discussed.
When you call, mention that you’re interested in a loan modification. Talk about your financial hardship and your preparation for completing the process. Ask what details they need to determine eligibility. If you qualify, your lender will provide you with the necessary documents for you to fill out.
If you’re considering a loan modification, keep in mind that the process from start to finish could take several months.
Pros and Cons of Loan Modifications
- Reduced interest rate
- Change in loan type
- Longer repayment period
- Short-term hardship
- Increased interest expense
- Reduced interest rate: A loan modification could lower your interest rate, which lowers your monthly payment and could reduce the amount of interest you pay over the life of the loan.
- Change in loan type: You could move from an adjustable-rate mortgage to a fixed-rate mortgage. This means your interest rate could change.
- Longer repayment period: Typical loan terms usually max out at 30 years. However, you could extend your repayment term, which lowers your monthly payment to something more affordable.
- Short-term hardship: Since loan modifications can take months to sort out, you could fall further behind on your mortgage with each month that passes. You may also incur costs, such as for an appraiser, as you work through the process.
- Increased interest expense: If you extend your loan terms, you could end up paying more in interest over the life of the loan.
Loan Modifications vs. Refinancing
Refinancing and loan modification might sound similar, but they’re not the same thing.
|Changes your current loan||A new loan replaces your old loan|
|Could lower your interest rate, monthly payment, or both||Could lower your interest rate, monthly payment, or both|
|Work with your existing lender||Work with a new lender or your existing one|
|Must show financial hardship, possibly falling behind on loan payments for several months||Can refinance any time, but you must pay closing costs again|
|Cannot cash out||Can cash out|
|No prepayment penalty||Prepayment penalty|
|Cannot extend the loan term||Can extend the loan term|
- If you’re struggling to pay your mortgage, a loan modification changes your existing loan terms to something more manageable.
- You might be able to change your interest rate, extend your repayment terms, or change other loan terms to make your mortgage payments more affordable.
- To qualify for a loan modification, you’ll need to demonstrate financial hardship. Loan modifications can take months to complete.
- Alternatives to loan modifications include forbearance and refinancing.