What Are Loan Modifications
A loan modification isn’t as common today as it was a few years ago when the housing market was adjusting to the financial conditions in the late 2000’s. A loan modification is a permanent change to the original note such as an adjustment in the loan amount, term or interest rate for example. The only other way to make such a change is with a refinance. But a refinance and a loan modification are in fact different.
With a refinance, the home owner applies for a mortgage in much the same fashion as when the home was originally financed. The owners complete the application and then provide specific documentation required by the lender. For example, a borrower states the gross monthly income is $5,000 per month. The lender would then ask for the most recent pay check stubs covering a 30 day period showing $5,000 per month in income.
Mortgage loan programs also ask there be a two year employment history so the lender asks for the last two years of W2 forms. For those who are self-employed or get more than 25 percent of monthly income from sources other than an employer, two years of federal income tax returns will be provided. To show there are enough funds available for a down payment and closing costs then copies of bank statements will accompany the application.
With a loan modification, there is no new loan application but instead the borrowers apply for a loan modification directly with the lender. A loan modification also reviews the home owner’s financials but instead of making sure there is enough income to cover the new monthly payments the lender reviews financials to prove there is a temporary or permanent hardship. This means documentation of unemployment or a layoff or perhaps evidence showing there is has been a medical hardship and unable to work. The lender will review the current income and assets of the individual asking for the loan modification and adjusts the monthly payment accordingly.
For example, let’s say there is a 30 year fixed rate mortgage with a monthly payment of $1,000. The original application had two borrowers both employed. One borrower was laid off and half the household income was removed. The lender can review the new financial situation and modify the existing mortgage to accommodate the lower monthly income to $600 per month. The lender will then issue a trial period for the new, lower payments. If the home owners make these new monthly payments during the three to six month trial period, the loan will be permanently modified. Without the possibility of a loan modification, a foreclosure would likely be the result. Lenders by far prefer a loan modification versus a foreclosure.
A loan modification isn’t meant to replace a traditional refinance. Borrowers who can qualify for a refinance and want to change the rate or term on their existing home loan will apply for a refinance. Borrowers who cannot qualify for their current mortgage due to loss of income can apply for a loan modification instead.