Understanding Loan Modification

Loan Modification

Loan Modification is a process whereby a homeowner's mortgage is modified and both lender and homeowner are bound by the new terms. The most common modifications are lowering the interest rate, reducing the principal balance, 'fixing' adjustable interest rates, increasing the loan term, forgiveness of payment defaults and fees, or any combination of these.

The need to modify an existing loan arises when a homeowner is either well behind on mortgage payments, in threat of foreclosure, owning an "upside down" property, or experiencing a financial hardship that makes it difficult to make regular mortgage payments.

A loan modification agreement is different from a forbearance agreement. A forbearance agreement provides short-term relief for borrowers who have temporary financial problems, while a loan modification agreement is a long-term solution for borrowers who will never be able to repay an existing loan.

Interest Rate Reduction

Lowering interest rate is one option in loan modification. If the interest rate is lowered, the payment lowers as well. In cases where a borrower showed a steady payment history at the initial rate, the lender will have no problem drooping the rate down so long as the borrower shows an explanation and proof of a financial hardship and would like to improve his situation. The lowering of the interest rate would make it possible for the borrower to resolve the mortgage payment delinquency and pay other debts as well.

Principal Balance Reduction (Temporary/Permanent)

In this case, the lender is forgiving a portion of the overall amount owed by the borrower. Lenders usually agrees to principal balance reduction in cases wherein the value of the property is worth so much less than the balance owed by the borrower that there is no reason for the homeowner to walk away from the debt. Besides, why would a homeowner continue making huge mortgage payments only to realize that he is paying for an "upside down" property?

Fixing Adjustable Interest Rate (ARM)

Borrowers are having a hard time coping up with Adjustable Rate Mortgage (ARM). This is one of the main reasons for delinquency in mortgage payments because it sometimes becomes too unaffordable due to a high adjustment on interest rates. Lenders will agree on a shift from ARM to a fixed interest rate so long as the borrower can prove that by doing so, he could now make and sustain payments on his mortgage.

Stretching of Amortization

This is usually done by lenders (e.g. from 20 years to 30 or 40 years) in order to lower monthly mortgage payment rates. This would make it easier then for the borrower to afford the monthly payments so as avoiding further delinquency.

Forgiveness of Payment Defaults and Fees

There are some cases wherein lenders waive mortgage payments defaults in loan modification. They are taking in consideration the situation of the borrower, that is why lenders sometimes forgive payment defaults and fees in order for the borrower to easily afford the update on his mortgage payments.

A single or any combination of these changes on an existing loan makes it possible for the borrower to update or continue his mortgage payments, avoid foreclosure or short sell of the property, and makes it easier to return in living a normal life and get out of financial hardship.