What is a Loan Modification and How Does it Work?

What is a Loan Modification and How Does it Work?

If recent financial or personal difficulties have left you struggling to pay your monthly mortgage payment, it’s natural to find yourself experiencing stress and anxiety about losing your home.

These hardships can range from losing your job or experiencing a medical emergency to being called up for military deployment.

If you’re having trouble making your monthly mortgage payments, you should know that you have other options besides losing your home. You may be eligible to apply to a bank for a loan modification, which would provide you with a lower, more affordable monthly payment.

At Loan Lawyers, we have decades of experience helping homeowners keep their homes by obtaining loan modifications. Let us help you through the loan modification process. We will fight on your behalf to lower your monthly payments and keep your home.

What is a Loan Modification, and How Does it Work?

A loan modification is a permanent restructuring of a mortgage or other long-term loan by changing one or more terms of the loan to provide the borrower with more affordable payment.

A loan modification may involve:

  • A reduction in the loan’s principal.
  • A reduction in the interest rate.
  • Changing the interest rate from an adjustable rate to a fixed rate.
  • Extending the loan term.

Generally, a borrower can only apply for a loan modification once he begins to experience financial hardship and difficulty meeting his monthly payments.

A borrower obtains a loan modification by applying to their bank or the bank’s loan servicer. In the application, the borrower first states that he cannot pay current monthly payments due to financial or personal hardship. They then provide emotional and financial information to allow the bank to decide if the institution is willing to accept a lower monthly payment than the borrower can more easily afford.

If they decide that a borrower can afford a lower payment, the bank will typically ask the borrower to complete a trial period, during which they must make their new monthly payments. At the end of the trial period, the bank finalizes whether to approve the borrower’s loan modification request.

Loan Modification Options

Any homeowner who needs to lower their monthly mortgage payments may have multiple options to modify their loan. Some standard options may include:

  • Capital reduction. If you have cash or other liquid assets available, you may be able to lower your mortgage payments by reducing the remaining principal on your loan. By paying off a significant amount of your mortgage principal, you may be able to renegotiate a much lower monthly payment for the remainder of your mortgage term.
  • Lower interest rates. Qualify for a lower interest rate and have enough home equity. You may be able to refinance your mortgage at a lower interest rate, lowering your monthly payments to a more manageable level.
  • Extension of loan terms. You may be able to negotiate an extension of your loan term. By extending the loan duration, you can lower your monthly payments by spreading the outstanding balance over a more extended period. However, by extending the time of the loan, you will end up paying more interest.
  • Change from adjustable to fixed rates. Many people apply for adjustable rate mortgages, attracted by the low-interest rates and payments. However, once the interest rate rises, they often can’t afford the higher monthly payments. It may be possible to reduce monthly costs to a lower, more manageable amount by converting or refinancing your mortgage from an adjustable-rate mortgage to a fixed-rate mortgage. This also allows you to plan for the long term with the knowledge that your mortgage payment will not vary or gradually increase over the years.
  • Deferment of payments. Suppose you or a family member is experiencing a temporary hardship, such as losing your job, becoming temporarily disabled, undergoing a medical emergency, or being called up for military service. In that case, you may be able to negotiate a temporary moratorium or extension of your mortgage payment. In comparison, this will give you a chance to stabilize your financial situation. Keep in mind that postponing payments does not post interest. You will continue to accrue interest on the principal during your deferment, which will increase your monthly payments after the deferment period ends.

Disadvantages of Loan Modifications

Although getting a loan modification may be your only option to control your mortgage payments and stabilize your financial situation, you should be aware that there are downsides to getting a loan modification. These include:

  • Negative impact on credit score. Although the loan modification may not affect your credit report or credit score, it may have a negative effect, depending on how your bank chooses to report the loan modification to the credit bureaus.
  • Loan processing costs and legal fees. Banks generally charge processing fees in connection with a loan modification application. The bank may be willing to add these fees to the loan’s principal, but doing so will partially offset the reduction in monthly payments. You may also have outstanding late fees, which can also be added to the principal of the modified loan. You may also need to hire an attorney or consulting firm to help you with the loan modification if your bank is challenging to work with.
  • Taxes. If your loan modification involves a debt discharge, you may have to pay income tax on the discharged debt, although federal law makes most discharged mortgage debt not subject to tax at the national level.
  • You failed the loan modification application. Although the bank may be legally required to allow you to apply for a loan modification, it is not necessary to grant you a chance. If the bank isn’t convinced that you can afford a modified loan, they may instead encourage you to sell the property, or you may start foreclosure proceedings as soon as you have the legal right to do so.
By Master James

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