What Exactly Does a Loan Modification Modify?

With so much talk surrounding home mortgage loan modification as an option to avoid foreclosure, it is important for borrowers to understand exactly what parts of their original loan are going to be modified if approved for such assistance.

Most borrowers understand that a home mortgage loan modification will modify the terms of their original contract, but they are not sure as to what terms will be modified.  In most cases, a person’s interest rate will be modified, which is especially true of adjustable rate mortgages.  Adjustable rate mortgages usually start off as fixed rate mortgages and become adjustable after a pre-determined period of time, causing the interest rate, and therefore monthly payments, to balloon.   A loan modification, in this case, would change a person’s interest rate on their original contract to one that is low and / or fixed. 

Another way that a lender will lower a monthly payment is by forgiving past late fees, which often get compounded onto the principal which slowly increases the monthly payment.  When a payment is missed, the amount of the missed payment as well as any late charges can be tacked onto the principal, increasing the monthly payment each time a payment is missed.  This tactic does little to help the borrower since it makes it more and more difficult for them to get caught up with their payments as each month passes.    

In general, a loan modification does not decrease the amount of the principal.  To do this would cause the lender to lose money, since they would have to collect less than the amount of the original loan.  This is not to say that lenders won’t forgive certain debts, which is usually the idea behind a short sale, only to say that a loan modification would not be the way to seek debt forgiveness.

A home mortgage loan modification only modifies the contract that binds the borrower to the lender; it doesn’t modify the amount that the borrower owes.  By changing the terms of the original mortgage contract, the lender agrees to adjust the cost of borrowing money, not the amount borrowed.  Lenders don’t usually agree to accept less than was borrowed. 

Many people will skip entire monthly payments if they don’t have enough to pay the minimum amount.  A loan modification seeks to prevent this for the benefit of both parties, since lenders would rather collect some money than no money at all and borrowers would prefer doing good for their credit score rather than bad.  The only way a borrower can begin to improve a suffering credit score is to begin making full monthly payments, one way for that to happen is for the lender to request lower monthly payments.  If both lender and borrower agree to the new amount, then the lender can stop reporting negative information to the credit bureaus.

Borrowers considering applying for a home mortgage loan modification should begin reviewing their mortgage contracts to have a general understanding of what may or may not be modified.  Knowing what is in the contract will also give the borrower a platform from which to begin negotiations.  Any attorneys that are hired to represent the borrower will also need to see the original contract so that they can see the entire picture from the point of view of their client.