A mortgage loan modification changes the original terms of your home loan to reduce monthly payments, eliminate arrearage, defer payments, and/or reduce the total amount you owe on your mortgage. Often, a modification is the best way to save your home from foreclosure. Read more to learn about the different government programs for loan modifications, the steps to getting a loan modification, and alternatives to loan modifications.
Written by Attorney John Coble.
Updated July 22, 2021
If financial hardship is making it difficult to make your mortgage loan payments, requesting a loan modification is a good idea. This article will go into detail about the many ways a loan modification may be able to help you. Often, a modification is the best way to save your home from foreclosure. The article will also discuss the different government programs for loan modifications, the steps to getting a loan modification, and alternatives to loan modifications.
Mortgage Loan Modification
A mortgage loan modification changes the original terms of your home loan to reduce monthly payments, eliminate arrearage, defer payments, and/or reduce the total amount you owe on your mortgage. There are various ways to achieve these goals. Some examples include reducing the principal, extending the repayment term, and reducing the interest rate.
Mortgage Loan Modification Options
The options that a homeowner has when it comes to mortgage modifications depend on their lender. Government-backed loans usually have more opportunities to benefit from loan modifications.
Principal reduction is another term for partial loan forgiveness. If you owed $100,000 and a mortgage servicer allows you to reduce your principal balance to $70,000, you could see this as a $30,000 gift. That's a 30% mortgage reduction. If this sounds too good to be true, it isn't. The Federal Housing Finance Agency (FHFA), the agency that oversees Fannie Mae, Freddie Mac, and the Federal Home Loan Bank, allows principal reductions up to 30%.
You probably need a government-backed loan to qualify for any principal reductions. Private lenders are in business to make a profit. They're not fond of giving money away.
Extended Loan Term
A loan modification can be used to extend a borrower's repayment term. This approach will lower your payments but increase the total amount you'll pay overall. See the example below for how this process can work.
|Extended Loan Term Modification|
|Loan Before Extension||Loan After Extension|
|Years Left on Loan||20||25|
|Total Amount of Principal & Interest Left to be Paid||$158,389.00||$175,377.00|
As you can see, extending the mortgage term for 5 years reduces the monthly mortgage payment by $75 per month. But, it increases the total amount left to be paid by approximately $17,000. The reason for this is with the longer term, the interest has more time to accrue.
Lower Interest Rate
If your interest rate is reduced, your monthly payments will be lower and the total balance left to be paid will be reduced as well. See the example below.
|Reduced Interest Rate Modification|
|Before Interest Rate Reduction||After Interest Rate Reduction|
|Years Left on Loan||25||25|
|Total Amount of Principal & Interest Left to be Paid||$876,885.00||$701,526.00|
In this example, an interest rate reduction from 5% to 2.87% results in a $585 reduction in the borrower's monthly payment. Fannie Mae and Freddie Mac’s Flex Modification Program allows for up to a 20% reduction in your monthly mortgage payment through a combination of mortgage extensions, interest rate reduction, and/or principal forbearance. This example results in a 20% reduction in the monthly payment through an interest rate reduction alone.
Postponing mortgage payments is also known as forbearance. Unlike the other modification methods mentioned, a forbearance is only a temporary solution. While you're in forbearance, interest continues to accrue on your balance. For this reason, after your forbearance period is over, you may need to pursue other loan modification measures.
Government Programs For Loan Modification
In the past, the Home Affordable Modification Program (HAMP) was the primary government program for loan modifications. Since HAMP expired, many government programs for loan modifications have arisen to replace it. Yet, for you to be eligible for these government programs, you need a government-backed loan.
The good news is the great majority of all new mortgages in America are government-backed. Banks, private mortgage companies, and credit unions "originate" most mortgages. The originators are the ones who make the mortgage loans to you. These loans may be backed by the Federal Housing Administration (FHA), the U.S. Department of Veterans Affairs (VA), the United States Department of Agriculture (USDA), or they may not be government-backed.
It may sound strange, but these non-government-backed loans usually become government-backed in a way. Most of these private loans are sold to the Federal Nation Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac). Both of these companies are publicly traded companies. That makes them private companies, right? Not exactly. These companies were created by an act of Congress and are subject to special oversight by Congress.
These companies have been taken over by the federal government through a conservatorship since the Great Recession. If your mortgage has been sold to Fannie Mae or Freddie Mac, you'll be able to benefit from the special requirements the federal government has enacted to help people keep their homes. For example, the CARES Act relief for homeowners applies to Fannie Mae and Freddie Mac just as it applies to FHA loans, VA loans, and USDA-backed loans.
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How A Loan Modification Lowers Your Monthly Payments
In response to the coronavirus pandemic, Congress passed the CARES Act. This act has provisions that mandate forbearances for the government-backed lending programs through the FHA, the VA, the USDA, and some other smaller government-backed loan programs. The CARES Act also applies to the government-sponsored loan pooling agencies: Fannie Mae and Freddie Mac. In short, the great majority of mortgage loans in America are eligible for this unique forbearance opportunity.
These forbearances can last up to 18 months. What happens when you start paying again? You will have a larger loan balance due to the interest that accrued during the time you were in forbearance. You will also have 18 fewer months to pay off your mortgage. Your interest rates will remain unchanged unless you have an adjustable rate mortgage (ARM).
For these reasons, a lot of people are going to need either a mortgage modification or a mortgage refinance after the forbearance ends. While you need a good credit score to refinance your mortgage, your credit report isn't as important when seeking a mortgage modification. Expect a lot of mortgage modifications to be processed after the forbearance periods run out.
Why A Loan Modification Is Good For Your Lender
Loan modifications aren't just good for you, they can be helpful for your lender. A mortgage lender is more likely to call these modification programs “loss mitigation.” This is because any loan servicer wants to limit its loss by avoiding the expenses related to collections and foreclosures. It's helpful for the lender to be able to maintain cash flow from you, even if the amount received is less than what it was getting before the modification.
How To Get a Mortgage Loan Modification
Different mortgage modification programs have different steps involved in their loan modification processes. It's a good idea to talk to a HUD-approved housing counselor to help you understand your options before you commit to a plan of action.
The two main steps to getting any type of mortgage loan modification are to determine if you're eligible and then apply.
There are loan modification programs available for all government-backed mortgages. Fannie Mae and Freddie Mac have the Flex Modification Program. You're eligible for this program if you have a Fannie Mae or Freddie Mac loan. You can determine this by using this lookup tool for Fannie Mae and this tool for Freddie Mac.
The remaining eligibility requirements are:
For your principal residence, you must be 60 days past due or default must be imminent because of some event in your life, like a job loss. If it's a second home, you must be 60 days past due.
The mortgage originated at least 12 months before the loan modification application.
You can't currently be in another foreclosure prevention program.
The mortgage hasn't been modified more than 2 times in the past.
You haven't failed a Flex Modification trial within the last year. Before being granted a Flex Modification, you have a trial period wherein you prove you can make the proposed modified payments.
If eligible, you can apply for the Flex Modification by filling out the Mortgage Assistance Application. You'll need to provide a Form 4506 so the servicers can verify your income through your tax returns. You'll also need to provide documentation of your financial situation, such as bank statements, pay stubs, and other financial information.
You’ll need to go over this process with your housing counselor to make sure you're getting everything right. Remember, the Flex Modification program is only one example of the government-backed options. Your counselor will know which option is best for you and the necessary procedure for navigating that option successfully.
Alternatives To Loan Modification
Loan modifications aren't the only way to make your mortgage more affordable. Refinancing your mortgage is another option. This is when you get a new loan and use the proceeds to pay off your current mortgage. The goal of a refinance is to get a more favorable interest rate. By lowering your interest rate, you'll reduce your monthly payments and the total amount you owe. This is a great approach if you have a credit score that's high enough to get a more favorable rate than the one you’re paying now. However, when you're having trouble making your mortgage payments, your credit score will already have taken a hit and you won't be able to refinance at a more favorable rate.
In a Chapter 13 bankruptcy, as a general rule, you can't use the bankruptcy to modify the first mortgage on your principal residence. This rule doesn't apply to a second mortgage that has no equity to attach to. It doesn't apply to the first mortgage on a second home. Last, it doesn't even apply to a first mortgage on the principal residence if that mortgage is cross-collateralized with other assets. So, there is a possibility that a Chapter 13 bankruptcy can eliminate a second mortgage or reduce a first mortgage.
You may not have enough income to support a Chapter 13 plan. A mortgage modification may solve this problem for you. Some bankruptcy courts, such as the Northern District of California, have streamlined processes to help the bankruptcy filers comply with the court's bankruptcy rules while trying to get a mortgage loan modification.
There are many ways to modify your mortgage to make it more affordable. If the mortgage is for your principal residence, it's best to pursue mortgage modifications as soon as you realize a mortgage default is imminent. Your principal could be reduced, your loan could be extended, and/or your interest rate could be reduced. If you need a mortgage modification, the most important thing to remember is not to wait until it’s too late to explore your options.