Some Disadvantages of Loan Modification

by tammy on May 4, 2010

As a general rule, the only time a borrower requests loan modification is when he or she is facing difficulty making the regular payments as originally agreed. This means, more or less by definition, that the loan modification is contrary to the ideal interests of the lender, though a loan modification may be a lesser evil than calling in the loan or forcing the borrower to default on it. As a consequence, the general rule is that loan modifications are usually only permitted when the borrower can make a solid case that he or she is unable to make the payments as originally agreed to.

Needless to say, since the collapse of the American residential real estate market in 2008, the subprime mortgage crisis, the credit crunch and the subsequent recession, the number of requests for loan modifications has skyrocketed. Further, since many of the mortgages were originally issued when the property values were much higher than they are today, it is frequently in the interests of the lender to maintain the old mortgage – based on the overvalued property – as opposed to foreclosing and then reselling at the newer, lower values. Therefore many lenders see loan modification as a better option than simple foreclosure.

Despite this reality and the fact that many lenders are much more willing to accept loan modification as a viable option today, they still hold it against the borrower. The argument being – fairly – that the borrower has still proven unable to carry out the agreement they originally signed on to. Therefore, in almost all cases, any loan modification is considered a negative and reported as such to the credit reporting agencies. Virtually anyone that gets a loan modification can expect their personal credit – and that of any co-signers – to take a hit.

The situation is even worse for people that opt to use the Making Home Affordable loan program offered by the U.S. Department of Housing and Urban Development (HUD). Although this program is tightly scripted and therefore easier to negotiate than voluntary loan modification negotiations, it is specifically designed to impose major strikes against the beneficiary’s credit. Before the loan is actually modified, the program requires a three payment trial period, during which time the person seeking assistance makes three payments at the new, adjusted rate. However, since the loan has not officially been modified during this period, these three payments are reported to the credit bureaus as three incomplete payments made on the mortgage payment spanning three months. This looks utterly horrible on anyone’s credit report and is enough to lower someone’s FICO score dramatically.

These strikes against the borrower’s credit are by far the most dramatic negative consequences to receiving a loan modification. There has been something of an outcry in the financial press against people that receive increased amortization periods or debt forbearance agreements (neither of which actually reduces the principal or the interest rates) receiving these strikes against their credit, but the industry has stood firm on the question. Quite specifically, anyone asking for a loan modification agreement has effectively admitted an inability to meet their financial obligations, and this fact should be reported on their credit report.

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