If you are at risk of foreclosure, your mortgage lender is going to talk to you about a loan modification. This idea has a lot of appeal to homeowners. If it works, you get to keep your home and make a lower payment every month.
You need to know that deciding to apply for a loan modification can create problems down the road. Some lenders will not allow you to pursue any other option – such as a short sale – while your application for a modification is being reviewed by your bank. Your lender, on the other hand, can continue the process of taking away your home while your application is being reviewed.
In the state of Washington, the only way to legally put foreclosure on hold for a time is to file for mediation.
We’ve found that some of the time a loan modification is NOT the best idea for homeowners.Here are 6 things you need to know before you decide to apply
- Truly beneficial loan modification approvals are rare. Many mortgage lenders follow federal government guidelines (called HAMP, for Home Affordable Modification Program) when considering whether to modify a loan in order for the lender to receive incentive payments from the government.
- The federal guideline is that your loan payment should be less than 33% of your income. The lender’s first option is to adjust the interest rate to lower your payment. The second step is to adjust the term of the loan, so that you pay a smaller amount for a longer period of time. If neither of these gets the payment low enough, the lender would need to forgive a portion of the loan.
- This sounds great to homeowners who have lost their jobs or other source of income. They apply, thinking the bank will reduce their monthly payment to something more manageable. But banks aren’t required to do any of these things for you. They are obligated to review your application for a loan modification, but they don’t have to accept it.
- Principal forgiveness, which is the best kind of loan modification, is actually fairly rare. Typically, you'll be given a temporary loan modification with a lower payment, while they determine whether to offer you a permanent loan modification. This process can take up a lot of valuable time. This brings me to my next point . . .
- Applying for a loan modification doesn’t necessarily stop the foreclosure process. When a representative from your mortgage lender talks to you about applying for a loan modification, that doesn’t mean they aren’t continuing to pursue foreclosure. But it can sound that way to a homeowner. Whether it’s wishful thinking on the part of the borrower or deliberate deception on the part of the lender, people often believe that when they’re in the process of applying for a load modification, their bank isn’t going to foreclose. In fact, most people are under the impression that this "dual-tracking" is prohibited. While it may be in some cases, in our experience, the clock keeps ticking while the loan modification is being reviewed.
- Worst case? Your lender finally tells you that you haven’t been approved for a loan modification and you immediately learn that a foreclosure auction date is set. Your options have become very limited at this point.
- Approval may not be the good news you thought it would be. If you get an offer to modify your mortgage loan from your bank, be sure to examine it carefully.
- Often these agreements start with great terms, but then have a built-in balloon payment due for a huge amount – sometimes in just 6 or 12 months you’d have a payment of $10,000 to make! That is not long-term relief. It only delays the inevitable. (And in the meantime, the bank continues to receive payments from you that you can never recover.)
- We’ve also seen lenders extend terms out to 55 or 60 years. The payments may have gone down, but you’ll be paying your mortgage forever. That’s not a viable solution for anyone who wants to retire someday.
- Keep in mind that just because you can (in theory) scrape together enough to make your mortgage payment, doesn’t mean this is the best solution for you. Freeing yourself from that debt – even if it means moving to another home – may be a better way to live. Consider what it means to have half your income gone before you even see it. What would happen if you had an emergency to deal with? What happens if you need to make some repairs to your home? What about retirement savings? What about just taking a vacation some day?
- The hard truth is if you can’t afford your mortgage now, you probably can’t afford a loan modification. You may be delaying foreclosure rather than preventing it. And then you’re left with nothing – not even your credit rating.
- Loan modification usually requires a three-month trial – with another review at the end. Even if you follow through with everything you promised on this three-month trial, the bank can still deny you a permanent modification! They will go ahead and foreclose after you have made thousands of dollars in payments in good faith, because you mistakenly believed you had a binding agreement. This seems incredibly unfair, but it’s totally legal.
- Lender reps may be required talk to you about loan modification options – even if they know it’s not going to work out. This sounds a little crazy. But, according to HAMP rules, mortgage lenders must actively solicit borrowers to participate in HAMP before referring a loan to foreclosure or scheduling a foreclosure sale. Just because your rep calls you and encourages you to apply for a loan modification, doesn’t mean there’s any reason to believe a loan modification is going to be approved – or that it’s a good idea for you.
- The loan modification process is time-consuming. You will be required to provide a lot of documentation – even more than you would for obtaining a mortgage in the first place. You have to account for all sources of income and all your expenses. This is a problem if you take two months to get all your documents together while your lender is continuing the foreclosure process. If you aren’t pursuing other options yourself, you can easily run out of time and lose your home if your application is denied.
When does a loan modification make sense for a homeowner?
You may be a good candidate for a loan modification if you experienced a temporary drop in income that made it impossible for you to keep up with your mortgage payments for a few months. If you have been re-employed and now have the income to make your mortgage payments, a loan modification can help you get back on track with your lender.
When it comes down to making a choice to try for a loan modification, remember the old adage: If it seems too good to be true, it probably is. While anything can happen, it’s not realistic to expect a lender to forgive your debt – after all, they are in business to make money.
Too many times we’ve seen homeowners pursue loan modification because they want so much to keep their homes – but, unfortunately, they end up not only in foreclosure but in a far worse financial position than where they started.
Our recommendation is that you get good counsel before you decide to go down this path. We would be happy to hear your story and talk with you about the pros and cons of every option you have, so you can make an informed decision. This consultation is free, with no further obligation.