For many homeowners struggling to make their mortgage payments, getting a loan modification is their last chance to save their home from foreclosure. A modification might result in a lower interest rate, a longer repayment term, forgiven debt (rare), or a principal forbearance (more common).
Your monthly payment amount will typically be lower after you get a loan modification.
A Loan Modification Is a "Loss Mitigation" Option
A "loan modification" is one "loss mitigation" option. Loss mitigation is how the mortgage servicing industry describes the process of working with the borrower to try to find a way to avoid foreclosure.
Potential loss mitigation options include a loan modification, forbearance agreement, repayment plan, short sale, and deed in lieu of foreclosure. Most people who ask for loss mitigation, though, want a modification.
How Loan Modifications Work
Completing a loan modification alters the original terms of the promissory note and mortgage to lower the borrower's monthly payments. To reduce the payments, the loan owner, called an “investor,” usually agrees to do one or more of the following:
- lower the interest rate
- extend the term of the loan
- forgive some of the principal (not common), or
- forbear some of the principal. (A “principal forbearance” is when a portion of the unpaid balance is set aside before calculating the monthly payment. This amount does not accrue interest and becomes due in a balloon payment, typically when the loan term ends.)
Investors usually won’t approve a principal reduction as part of a first-mortgage modification.
Also, any past-due amounts are usually added to the outstanding principal balance as part of a modification.
Available Loan Modification Programs
Government programs and in-house (called “proprietary”) loan modifications are generally available for qualifying borrowers. Depending on the type of loan you have and your circumstances, you might be eligible for:
- a Fannie Mae or Freddie Mac Flex Loan Modification (applicable to those with Fannie Mae and Freddie Mac loans)
- an FHA modification, like FHA-HAMP (if you have an FHA loan), or
- a proprietary loan modification.
Loan Modification Application Process
To apply for a loan modification, you must provide a lot of documentation to the servicer. Often you’ll need to submit the following:
- a completed application
- recent pay stubs or a profit and loss statement if you’re self-employed
- bank statements
- tax returns
- an income/expense financial worksheet, and
- a hardship statement or affidavit.
To start the process and get instructions about the specific documents you’ll need to provide, contact your servicer’s loss mitigation department (sometimes called a "home retention department"). You can typically find contact information on your monthly mortgage statement or the servicer’s web page.
Not Everyone Who Applies Gets a Modification
People who’ve experienced a drop in income that led them to fall behind on the loan payments (or are in danger of falling behind) but have sufficient income to keep up with modified payments tend to be good candidates for a loan modification. Unfortunately, many people who request a loan modification get denied.
Still, it doesn’t cost anything to apply, so you might as well take a shot. While the law doesn’t require the investor to give you a modification, federal law does require the servicer to at least review your application.
You should be aware that initiating the application process won’t stop a foreclosure. The law doesn’t protect you until your application is complete. Under federal law, if you submit a complete loss mitigation application more than 37 days before a foreclosure sale, the servicer can’t move for a foreclosure judgment or order of sale, or conduct a foreclosure sale, until it reviews the application and:
- the servicer denies your request for a loss mitigation option, and your time to appeal that decision expires
- you decline the loss mitigation option that the servicer offers you, or
- you agree to the loss mitigation option that the servicer offers, but you don’t live up to the terms of the deal, like if you don’t make the required payments during a trial modification.
So, if you take several weeks or months to gather all of your documents before completing the application, the foreclosure will continue during that time.
Beware of Pitfalls Even If You’re Approved
If your modification application is approved, review the terms of the deal carefully. While the new loan agreement might have a lower monthly payment, be on the lookout for conditions that aren’t so favorable, like a balloon payment for a considerable amount after just a few months or years.
Also, beware of modifications with very long terms, like 50 or 60 years. That’s a long time to be paying off a mortgage.
And if you think you’ll have to struggle to come up with enough money to make the modified payment each month, you might be better off declining the modification. Getting out from under an unaffordable mortgage and finding a cheaper place to live could make more financial sense, especially if agreeing to the modification merely delays a foreclosure rather than prevents it.
Talk to a Lawyer
If you need help completing your application or are having problems dealing with your servicer, consider talking to a foreclosure lawyer or a HUD-approved housing counselor.
You should, however, avoid hiring a loan modification company to help you.