Loan modification has become a household term with the recent banking crisis yet most homeowners don’t actually know what they are in for when they sign these papers. Educate yourself on five common misunderstandings about loan modifications and avoid getting into an undesirable situation.
MYTH 1: Modifying your loan will lower your payment.
When a loan is behind on payments, the taxes and insurance often lapse as well. The bank is then responsible for these payments and when they pay them it results in an escrow shortage. When your loan is modified, the escrow balance is added to the principal balance of the loan. In an effort to avoid another possible escrow shortage, the bank often doubles the normal monthly escrow payment which can result in a higher mortgage payment after the modification.
MYTH 2: The modification payment will not change.
Once you sign your loan modification papers, do not be surprised if the payment on your bill is different from your modification paperwork. Some modifications are “step-rate modifications” meaning the interest rate changes or “steps up” after a set amount of time. Review the modification paperwork completely and make sure it says “fixed rate” and the term for which it is set.
MYTH 3: The length of your loan term will remain the same after the modification.
When modifying your loan, the bank has to make sure your income can support the new payment. In order to make the payment fit your income, the bank will often extend the term to as much as 40 years from the date the modification is signed. If you are already 10 years into your loan you could end up paying on your home for half a century!
MYTH 4: You will own your home outright when the modified loan is paid off.
Another approach banks take to fit the payment to your income is to add a “balloon payment”. This is a lump sum that becomes due when your loan term is up. The balloon payment can be for as much as 50 percent of your initial principal balance. Unless you are able to pay that amount in full, the bank repossesses the home.
MYTH 5: Loan modification will not negatively affect your credit score.
If your loan payments are behind when you request a modification, the bank continues to report you delinquent while the loan modification is in process. If you are caught up on your payments when you request the modification it is important that you keep making your original payment until you receive a bill with the new payment amount.
The best way to avoid getting into an undesirable modification is to completely read your modification documents before you sign them. Stay in constant communication with your bank during the modification process to ensure you are doing everything possible to keep the ball rolling. It is not in the bank’s best interest to repossess your home and they will do almost anything they can to keep you in it and keep your payments current.