Loan modifications have almost become commonplace when it comes to real estate finance.  There are several reasons for this. People simply can’t afford their current mortgages, due in large part to the terms of their original home loans. Some loans were taken out with teaser rates as low as one percent, and after a few years, that rate morphed into six to nine percent. Some folks were laid-off and if they were lucky, were able to get hired, but at a much lower pay-rate.  If banks were to foreclose on every loan on their books that were delinquent, they would likely have gone out of business. Banks are as motivated to provide loan modifications as borrowers are in obtaining them.

A loan modification is simply a lender agreeing to “modify” the terms of an existing mortgage to make it more affordable for their borrower customers. An important clarification is that loan modifications are not “new loans,” but simply revisions of old loans.

Be Cautious When Selecting a Loan Modification Company

There are many loan modification (loan mod) companies that have sprung up in the last few years. Some are legitimate and many are not. Firstly, beware of any loan mod company that wants you to pay up-front fees. Federal law prohibits these companies from taking up-front fees. Some companies try to circumvent this by affiliating with lawyers who are allowed to take up-front retainer fees. If you are approached by this type of operation, contact your regular family attorney or a reputable law firm and ask the lawyer if the loan modification proposal sounds legitimate.

How to Apply for a Loan Modification

The best way to start the loan modification process is to contact the customer service department of your existing lender. Most lenders, particularly banks, have a department devoted to this. Some call these departments “Loss Mitigation Departments” and others simply call them “Loan Modifications Departments.”

They’ll ask you to complete their version of a loan modification application. You’ll need to provide income and asset documentation like you did when you took out your original loan. You will also need to provide an explanation letter as to why you are behind or couldn’t afford the current payments. Typically banks will consider loan modifications when borrowers generally have good credit (with the exception of their current home loan) which they can’t afford. They will also consider things like unusual, catastrophic events such as illnesses, a death in the family or work related issues such as the shut-down of a plant.

First and foremost, they’ll consider a loan modification if they think there’s a good prospect that the borrower will be able to make the new payments without defaulting. When assessing the borrower’s ability to make payments lenders look at the borrower’s income ratio. This is the ratio of the borrower’s fixed debt payments such as the proposed new, modified payment along with any car payments or other fixed installment loans. For example, if your fixed, monthly debts including the new, proposed modification are $3,000, and your gross monthly income is $7,500, your income ratio would be 40 percent ($3,000 divided by $7,500.)

There is also a federal program called “Make Home Affordable Federal Modification Program” that you may qualify for. Contact your existing lender to see if this special program applies to you.

When Lenders Won’t Consider a Loan Modification

Loan modifications will likely be rejected if the borrower has lived in their home for only a short time period. The general rule is one year, but this varies from lender to lender. Poor credit is another reason lenders won’t consider a loan modification. This sounds a bit ridiculous since many borrowers do have poor credit if they’ve gotten behind on their mortgage, however banks will still look at the overall credit picture to see if the borrower is habitually late on all their obligations and not just their mortgage.

Things the Lender Will and Will-Not Usually Modify

Most loan modifications involve a reduction in interest rate. This varies widely but can be as much as 2 to 3 percent interest. In other words, if the current loan is at 6 percent, the loan modification may take the rate as low as 3 percent.

Lenders will rarely modify the principle loan balance. Also if the borrower is several months behind on the mortgage, most lenders will add these late payments to the current loan balance, and this revised balance is what the loan modification payments will be based on.

The Big Picture – Banks and Loan Modification

You might wonder why banks would consider lowering the interest rate on their loans, but they are often just as anxious to work out a deal as borrowers due to the fact that accounting rules for banks and their assets changed a few years ago. In essence  if a bank forecloses on a property, it loos bad on their books. In accounting terms, it’s a non-producing asset and that reflects poorly on them. However as long as they still have a borrower on the property, even if the payments are delinquent and the property’s value has been drastically reduced, on paper, it’s still the same loan it’s always been. Banks don’t like to take properties back in foreclosure. It’s not the business they are in. So if you think you may qualify for a loan modification, contact your lender today!