When You Do a Loan Modification Does it Show on Your Credit?
A loan modification is a gift to homeowners facing unmanageable mortgage payments or other financial difficulty. Modifications reduce the amount of the monthly payment and bring the loan to a current status. Loan modifications became popular at the height of the housing crisis of the late 2000s as more homeowners fought to save their homes. Unfortunately, modifications to an existing loan sometimes reflect negatively on a credit rating. Recent government guidelines have helped to establish guidelines for credit reporting and homeowners may benefit from these.
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Loan Modification
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Lenders grant loan modifications when a homeowner can no longer afford the current payments due to financial hardship but is able to pay a lower rate. The loan is modified by reducing the interest rate, extending the repayment period or converting to a fixed rate mortgage from an adjustable rate one. Lenders are often more willing to modify a loan than face the foreclosure process. In 2010 alone, over 1.4 million loan modifications have been processed according to the HOPE NOW alliance. A loan modification differs from a refinance due to the fact that the existing loan is modified. Refinancing involves paying off the old loan and reissuing a new loan.
Credit Reporting of Loan Modifications
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The effects of a loan modification on a credit rating depends mainly on how the lender reports the modification. If a lender reports the modification as a settlement or adjustment to the terms of the loan, then the effect may be negative because the report will show that the original terms of the loan were unfulfilled. Reports will often show a partial payment plan status, which is viewed by lenders and creditors negatively. Many homeowners considering loan modification may already have late payments on their credit file, which are more damaging to the overall credit report. Some lenders consider loan modifications only after the homeowner has missed payments, which means that the credit rating has already suffered. Not all lenders have this requirement and it is not a requirement of the Making Homes Affordable Program.
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Trial Modifications
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In some cases a lender will propose a reduced payment schedule to the homeowner, which if the homeowner maintains for a set period of time will become permanent. This is referred to as a trial modification. It is important to ask the lender how payments will be reported during the trial period. Some lenders have reported these payments as late or are showing the loans as not current. This will have a very negative effect on credit ratings. The government, in connection with the Making Homes Affordable Program, has issued a guideline to lenders asking them to reflect these payments as current on a modified schedule. This wording still causes a negative impact to the credit rating but not nearly as much as missed payments will.
Making Home Affordable Plan
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New credit reporting guidelines for homeowners under the Making Home Affordable Plan make it easier to protect credit ratings. On November 1st, 2009, a new designation for reporting loan modifications was unveiled. The new statement on the credit report reads "Loan Modification Under Federal Government Plan." FICO scores are unaffected when using this new designation. Unfortunately, this only extends to homeowners under the government's plan. There are guidelines posted for lenders and homeowners on the Home Affordable Modification Program website.
Other Considerations
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Credit ratings determine interest rates, employment and deposit terms, so keeping a score healthy is important. Foreclosures are extremely detrimental to a credit rating, so homeowners must carefully weigh the options when making a decision about loan modifications. Refinancing does not have a negative impact to a credit rating, so if this is a viable option it is worth researching. If credit rating concerns are keeping you from choosing a loan modification, talk to your lender. Some lenders may not report the modification as an adjustment, especially for loyal customers.
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