The Disadvantages of a Loan Modification

by tammy on May 28, 2010

As a general rule, any borrower requested modification of a mortgage loan can be safely assumed to be detrimental to the overall interests of the lender. The borrower would not be asking for the loan modification unless they need to be paying less to the lender each month and no lender would even consider loan modification unless the borrower was plainly in dire financial shape and loan modification seems like a lesser evil than foreclosure. Therefore, lenders view loan modification negatively and this is reflected on the borrower’s record.

First and foremost it has to be understood that loan modification does not necessarily mean that the overall amount of money owed to the lender will change; it just means that the base amount of money paid each month will be reduced. The most common form of loan modification accepted by lenders is simply extending the life of the loan. The standard upper limit of this process is ten years and there really is no lower limit. The basic idea is that the life of the loan is extended, the monthly payments decrease as they are scattered over more payments for a longer period of time. There are also other ways of modifying a loan which can result in reduced monthly payments without actually reducing the amount owed, including using creative ways of calculating and assessing the interest and waiving or freezing the assessment of additional fees and penalties.

It is extremely uncommon for a lender to agree to a loan modification that actually results in a reduction of the amount of money owed. This can and does happen on occasion, but only under very specific circumstances. First, the borrower has to be facing eminent default; meaning they are not just having trouble making their payments, but if immediate relief is not provided they will be defaulting almost immediately (within the next two or three months). Second, the lender has to view loan modification as the most advantageous option available. If the property is going up in value and is desirable, meaning that it can probably be resold – then it is better for the lender to repossess and resale the house. If the house is in a depressed area and seems unlikely to sale easily and the existing mortgage is for considerably more than a new mortgage could fetch for the property, then a lender might consider reducing the interest or principal owed through loan modification.

Regardless of whether or not the overall amount is reduced, the amount paid each month is reduced (as otherwise the loan modification would make no sense) and this is detrimental to the lender. Any loan modification will be reported on your personal credit report and it will be reported as a negative. The basic standards are set by the Consumer Data Industry Association (CDIA), the trade organization of the credit reporting industry, and they clearly state that any loan modification – whether it results in an actual decrease in the amount owed or not – is reported as a strike against the borrower’s credit record. Despite the fact that there have been protests that this seems unfair, especially when the actual amount owed is not reduced, the lenders have a vested interest in discouraging loan modifications so it seems unlikely that they will agree to stop reporting them.

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