In the past, if a person got behind on their mortgage payments, they had very few options. Either they could try to increase their income, get another loan at a higher rate, try to refinance, or they could sell the home. Without these approaches, unavoidable foreclosure loomed over them.
Today, there is a new option that makes all kinds of sense (and cents!). This is called Loan Modification. We’re going to take some time to help you understand just what a loan modification is and how it can help you.
First, let’s just make sure we understand what foreclosure is. When we borrow money from a bank, we are essentially agreeing to a contract wherein the bank buys the house for us and we pay the bank an agreed upon amount, with agreed upon interest, until the cost of the house is paid back. What this means, of course, is that the bank owns the house.
What this also means, less obviously, is that your house is not always an asset. If you have a large chunk of equity and you are able to easily make your house payments every month, the house is sort of an asset. However, if you are in a risky loan with difficult payments and a depreciating home, your house is a massive liability.
Truth is: your house is only an asset if it is paid off. Assets should make you money, but when you still owe money on your house, you are probably not making any money off of it.
So back to foreclosure. Foreclosure is when the lender decides the borrower is not going to be able to continue to faithfully pay on the loan, probably due to a history of non-payment, and the lender says the loan is in default and that they are going to repossess the home. Basically, the bank takes the home back, since they are the ones who really own it.
With an understanding of foreclosure, we can move on to loan modifications.
Loan Modifications: The What
A loan modification is exactly what it sounds like: a change to your loan agreement. This change can come in a variety of forms, which we will cover momentarily, but it is simply a change to your existing loan agreement.
A loan modification is not a refinance. It is not a home equity line of credit. It is not an unsecured loan.
When you get a loan modification, you stay in the same loan that you already have, but some of the terms of the agreement change. The point of a loan modification is to have a lower, more affordable payment on the loan that you already have with a lender. We will talk about why a lender would be willing to make these changes in the next section, but suffice it to say, loan modifications are not pipe dreams. They are real and they can make a substantial difference in your monthly budget.
Now, as we’ve mentioned, a loan modification changes a term, or terms, of your existing loan. The most common terms that might be able to be changed through a loan modification are:
* Lowering the interest rate.
* Extending the loan payback period (say from 25 years back to 30)
* Skipping some payments (usually these are appended to the back end of the loan, so the skipped payments become the last payments you make)
* Forgiving some principle (this is more common in homes which have depreciated, resulting in the borrower owing more than the home’s fair market value)
Again, the purpose of changing these loan terms is to reduce your monthly payment to something you can afford. Now let’s discuss why a lender would even consider modifying your loan.
Loan Modifications: The Why
Imagine you are a lender and that you let someone borrow money from you so they could buy a house. You and the borrower agreed to some terms for payback of the borrowed money, with one of those terms being that interest would be charged and the borrower would pay some interest with every payment they make.
This is a great way for you, as a lender, to make money without working. However, let’s say the borrower stops making payments and the housing market crashes, so they can’t sell the house to get out of the loan.
Do you want the house for yourself so that you can struggle to sell it or do you want to at least make some, or most, of your money back? Clearly you want to make your money back, rather than ending up having to take the house back and then sell it at a very discounted price.
This is why banks are interested in loan modifications. If they can change the terms of the loan sufficiently that you can afford to keep paying them for many years into the future, they will be happy. They make much better money off a mortgage that is being paid back than they do off a home that they have to go through the trouble of having to repossess.
At this point, it should be clear why a lender would be interested in negotiating your loan and changing some of the terms. The next issue is how to go about getting a loan modification.
Loan Modification: The How
In order to get a loan modification, you have two options: do it yourself or get somebody else to do it for you.
Do it Yourself
To get the loan modification ball rolling, you simply need to contact your lender and ask about what options they might have for modification. Because of the recent financial climate, lenders are more motivated than ever to make adjustments to the terms of loans. They see, as the government does, that some of the loans they are holding are toxic and are only doing them harm. Thus, they see that they need to start turning a substantive profit.
Hence, lenders are in general more ready to consider modifying loans. Some lenders are even creating plans and packages to simplify the loan modification process and make it more accessible for their borrowers.
So to do this process yourself, you just need to ask. There are a few things your lender is going to look for before they decide to start the loan modification process:
* They will expect you to be behind on payments.
* They will expect to see that you don’t make enough income to cover your mortgage payment and your other monthly expenses.
* Adjustable rate mortgages that are about to adjust, or have recently adjusted, in a way that will make your payment go up are good candidates for loan modifications.
* Negative amortization (Neg-Am) loans are good candidates for loan modifications as well. Amortization is the word used to describe the death, or pay-off, period of the loan. A loan amortizes over the length of time you are paying it off. So a Neg-Am is actually an interest-only loan, which means your monthly payments don’t go toward the principal of the loan. They only pay the interest that the loan is accruing.
The last two cases are the type of loan that most lenders are going to be most interested in negotiating. However, even if you have a conventional loan that you simply can’t make payments on due to financial distress, it’s worth looking into the loan modification process. Some of the financial distress that you need to show your bank:
* A reduction in income
* Loss of employment
* Sudden increase in expenses, without an increase in income
If you are in a situation described in the above bullet points, it’s definitely worth talking to your lender about loan modification. Now, if you do this on your own, you need to expect to spend large chunks of time on moving the process forward. You also need to know how much you can expect to reduce your payment, so you will want to know which terms of the loan you are hoping to negotiate.
The truth is, doing the loan modification on your own is possible, but is a massive hassle and can be very difficult. You have to remember that banks don’t have your best interests at heart and that they know the system far better than the average person. So you might want to consider getting a professional or expert to help you out.
Getting help with your loan modification might be the best way to go. This is because if you find a professional who really knows what he or she is doing, they can save you scads of time and loads of money. Sure, the expert will charge a fee of some kind, usually $1000-4000 for the reputable folks, but here’s why they can still save you money:
* The expert, if they are worth their salt, will do an analysis of your situation to see if a loan modification is even possible. Some agencies charge for this, but there are some good ones out there that don’t. Or maybe they will ask for a deposit that is refunded if a loan modification isn’t going to work for you. This way you don’t even start the process until you know it’s going to work out.
* As soon as the negotiation process has begun, you stop making your mortgage payment. This process can take 2-5 months. The payments you don’t make during that time are usually included in the loan modification, meaning you never pay them. How’s that for savings?
* Your loan modification should bring your monthly payment down about 20-30%.
If you consider how much money you will save by getting a loan modification, it’s clear that using a professional doesn’t have to give you any net cost. Essentially an expert will pay for themselves with how much money they save you by seeing the loan modification process through.
Conclusion and Warning
By now you should have a handle on what a loan modification is and whether it could be a good option for you. In fact, you may think that a loan modification sounds too good to be true.
Usually, something that sounds too good to be true is just that: too good and thus it is not true. Usually something is missing, like the fine print.
This being the case, you need to know that there are still financial predators out there who want to take advantage of people. You can avoid these people by not paying attention to the cardboard signs you see posted at intersections. Don’t click on banner ads. Don’t rush into anything.
Make sure any agency you use has been in business since well before the economic crisis began and that they have a good reputation. Try to find one that has been recommended by people you trust.
Finally, a loan modification is not a strategy that anybody should use in the hopes that it will bail them out of a situation gotten into due solely to crummy spending habits. A loan modification is just one strategy that can help a person dig themselves out of a rough financial situation. Debt relief doesn’t begin and end with loan modification. Debt relief begins with changes in your spending habits.