What is a loan modification and how does it work

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At some point in almost everyone's life, owning a home becomes the next logical step.

And while our society has become accustomed to borrowing money to purchase a home and holding a mortgage, most people don't learn just how complex that process is and what can happen during the course of a mortgage's life.

When you take out a mortgage for a home, you're entering into a very long-lasting arrangement with a bank that is going to be lending you money that you pay back over the course of 15-30 years.

That's a lot of time, and many things can happen in 15-30 years.

That might include the market changing and you want to change the terms of that loan.

It might also include your career path changing or life events happening that cause you to fall behind on your mortgage payments.

Banks know this, and they've created processes to help you make those changes to an existing loan when needed -- and that's what they call a Loan Modification.

How does a loan modification work?

A loan modification is a change of terms to your mortgage, usually due to a financial hardship.

What changes in your mortgage can differ, depending on the issue that you and the lender are attempting to resolve.

In some cases this might be an attempt to reduce monthly payments because they are too high, and in others it's to prevent foreclosure by appending your missed payments to the existing balance on the loan.

Who qualifies for a loan modification?

Qualifies for a loan modification depend on the details around the loan. Because the process is so similar to getting a normal mortgage, there's not a one size fits all answer to this.

Depending on what you are trying to modify, the qualifications will be slightly different.

For instance, if you have missed payments and the loan modification is to get you back in good standing, the lender may need to verify that you can in fact continue making payments once the modification is complete.

One thing to note is that loan modification requests tend to be easier and more likely to success when it's on a primary residence, as opposed to a secondary or investment property.

Is a loan modification a good idea?

If you are able to get a loan modification and you have the ability to keep up with the payments, then yes.

However, if you already know that you won't be able to keep making payments on the property, it could be better to sell your house than to complete the loan modification in order to keep it off your credit report, provided that you have time.

If you don't, then it might be best to file that Request for Assistance…

Does applying for a loan modification stop foreclosure?

Yes, it can!

If you are facing foreclosure, it's important to get started because, according to the Department of Justice Settlement, once you file the Request for Mortgage Assistance, the lender is required to stop the foreclosure process upon receipt.

This doesn’t keep you out of foreclosure definitely, but it will buy some time so that you can either sell the house or complete the loan modification and get a new loan.

You can do this as close as a few days to the foreclosure auction, but don't cut it too close.

You can also refer to our article on ways to stop foreclosure at the last minute for more helpful options.

Can you be denied a loan modification?

Yes, your lender can deny your request for a loan modification for a variety of reasons.

  1. If your application is incomplete or there are issues with it, the lender may deny it and you would be forced to apply again or appeal.
  2. The lender may also deny the application if it's unclear that you'll be able to continue making payments once the modification is complete.
  3. On the flip side, they may deny it if it appears that you are currently able to make your payments and they have no reason to consider a hardship.
  4. When making your application for a loan modification, the lender will ask you to write a letter of hardship, in which you must detail the circumstances that caused you to fall behind on your payments.

    Think of it as making your case: Provide as much detail and documentation as possible.
  5. You were already approved for a loan modification and it's been less than 12 months since. If you're going into foreclosure, then you may consider filing for bankruptcy to buy more time until you can apply for another loan modification, but this is a risky move and could result in getting denied again.
  6. If the lender accepts moving forward with a modification, they will try a 3 month trial period. If you miss one of these payments, then they will deny the full loan modification.

What do underwriters look for in a loan modification?

When a loan modification requests is received, the underwriter's job is to look for pertinent details in the application that follows a rubric that the lender has internally set.

These will include details from the borrower such as:

  • The hardship and whether it falls in line with what the lender considers to be a valid hardship
  • Evaluating the borrower's financial status, current income, and ability to pay if the loan modification were to be approved
  • Look for and identify any potential fraud issues if they exist

Other things that the underwriter will look for:

  • Evaluate the current market value of the property
  • Identify if completing the loan modification will actually bring the lender a positive benefit in cash flow
  • If so, the underwriter will also look for ways to make sure the borrower can stay in good standing in the future, which might include lowering monthly payments or changing terms

Remember, the underwriter works for the lender. Usually, keeping a loan in place is much better than foreclosing on a house.

But if they find that they will spend more resources and money going through a loan modification only to have to go through foreclosure again, then they will deny the modification and move forward.

What is considered a hardship for a loan modification?

A valid hardship is something that has caused you to not make payments that were out of your control.

Examples of this could be loss of a job, medical bills, a death of a coborrower, a divorce, or natural disaster.

There will be some differences, lender to lender, that might consider different events as valid forms of hardship, but these are the most common among them.

How much does a loan modification cost?

Because a modification is being done to an existing loan, there aren't any closing costs associated with it.

However, there may be fees involved from the lender that they tack onto a modification, especially if you were already facing foreclosure.

The lender will apply the outstanding balance and reinstatement fees to the back of the loan when they modify it.

How long does a loan modification last?

The loan modification process can take 30-90 days, and if accepted, will include a 3 month trial period.

Once the loan modification and trial period are complete, that's it -- it's done and your mortgage is now back in good standing and in place for the life of the loan.

One thing to note is that if your modification is adding missed payments to the end of the loan, your loan may be reset back to 30 years.

Can you sell your home after a loan modification?

Yes, but only when your loan modification has been permanent (after the trial period).

You may need to see if there is any sort of prepayment penalty, but in many cases there is not. Once your loan modification is fully complete, it's just a standard mortgage and you can sell your home.

How often can you modify your mortgage?

Your lender will automatically deny loan modification requests if they are within 12 months apart.

However, if you experience hardship after that 12 month window, you can apply for another loan modification. The lender will evaluate it, and if the hardship is the same as before, it could lead them to denying it.

Can you be foreclosed on during a loan modification?

No, lenders are federally prohibited from foreclosing on your home while there is an active loan modification application under consideration.

If, however, the modification is denied, then the lender may move forward with the foreclosure.

What is the difference between a loan modification and refinancing?

The biggest difference between a loan modification and a refinance is that in a refinance, there is a totally new loan. This new loan actually pays off the old one, typically in exchange for a loan with a better interest rate.

A loan modification simply modifies an existing loan, but it is the same mortgage as before.

How many times can you appeal a loan modification?

If your loan modification is denied, the first thing you need to do is carefully read the denial letter.

The denial letter will state the reason for the denial, which can give you clues on what to do next. If the application simply wasn't completely appropriately, then that is something they'll state and you can immediately appeal it by fixing the issue.

If your loan modification was denied due to a missed trial payment, then you may be able to convince them to get you a second trial, depending on the reason. If it's due to a lack of income, then you'll need to increase that in order to get approval.

The biggest thing that will help with your appeal is proving a chance in circumstance. This could be an increase in income, change of jobs with proof, decrease in expense, among other things.

If the loan is backed by the government, then you can appeal your denial once within 14 days of the decision.

In other cases, you may have up to 30 days to make that appeal.

If your appeal is denied, you may not get another opportunity unless you can prove to them that you had a drastic change in income or expenses.

How do I get a loan modification approved?

The best way to ensure a successful loan modification is to review what the underwriters will be looking for, and to NOT miss a payment in your trial modification.

To get started, you just have to get in touch with your lender and begin the loan modification process.

They will walk you through the application process, the information that they will need from you, including personal information, proof of a job/income, and a letter of hardship stating a valid hardship, as described above.

What happens after a loan modification is approved?

Once the loan modification is approved, you'll go through a trial modification where you must not miss a payment for three consecutive months.

If you do miss a payment, then the modification is denied and you'll have to request another trial.

If you successfully make the trial payments, then the loan modification will  be made permanent and your mortgage will successfully be modified. After that, it is complete.

Is a loan modification a second mortgage?

No, a loan modification is a chance to an existing mortgage and does not "add" a mortgage. Your modification be on for your second mortgage, but that doesn't mean it is by default.

Is a loan modification a new loan?

A loan modification is not a new loan. It is a modification to an existing loan.

Can I sell my house while in forbearance?

Yes, the bank may allow you to sell the house while it's in forbearance.

If it's clear that you won't be able to make payments on the mortgage and a loan modification isn't a good option, then the bank may even help by extending the forbearance if it's clear that you're attempting to profitably sell the property.

Because this would prevent losses for the bank, they are more likely to work with you.

How long is mortgage forbearance?

Forbearance can last anywhere from one month to twelve months, depending on your situation and what your mortgage/lender allows.

During forbearance, your balance owed for those payments will continue to accrue, so they aren't completely forgiven.

Alternatives to Loan Modification

If you find that a loan modification isn't the right option for you, or if your lender denied the modification while you're under financial strain, consider selling your house to get out from the mortgage.

As discussed above, by selling the property, you can prevent the lender from foreclosing on the property and any additional damage to your credit.

That can allow you to purchase another home later when you get back on your feet.

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