Financial hardship due to the loss of a loved one, loss of a job, or natural disasters, for instance, are some of the many reasons people struggle to pay their loans. Fortunately, loan modifications exist to provide debt relief. What’s a loan modification and how to get a loan modification approved?
What Is A Loan Modification And How Does It Work?
If you’re starting to fall behind your loan repayments or struggling to pay back a loan, you can request your lender to make changes to one or more loan terms so that you don’t default. It’s a process called loan modification.
It helps make your payments more manageable by reducing your interest rate, extending the repayment term, reducing the principal balance, or adding any unpaid interest to your principal balance (the amount you borrowed).
What Are The Steps To Follow When Getting A Loan Modification?
- Contact your lender.
- Explain why you’re struggling to meet your repayment obligations.
- Provide a detailed explanation of your current financial difficulties.
- Fill out a loan modification application form.
- Provide all the required documents including your financial hardship letter.
Why Should You Consider Loan Modification?
A loan modification applies to all types of loans, but it’s commonly used for mortgage loans. Lenders try to avoid charge-offs (creditors declare that your debt is unlikely to be collected) and costly foreclosure process (the lender seizes your mortgage property as payment for a defaulted mortgage loan).
So, if you’re in financial hardship and can no longer pay your debt, lenders may be more willing to change the existing terms of your mortgage loan. You just have to take the initiative to quickly inform the lender at the earliest opportunity.
What Are The Advantages And Disadvantages Of A Loan Modification?
Loan modification offers several benefits, such as the following:
- Relief from financial stress
- Lower and more affordable monthly payments
- Lower interest rates
- Avoid foreclosures (if you’re trying to modify the terms of an existing mortgage loan)
- Protect your credit score from taking a hit from late or missed payments, or worse, bankruptcy or foreclosure
- Stop late payment fees from piling up
Even so, like all the other types of financial transactions, loan modification also comes with some disadvantages.
- The changes in the terms, especially if it involves extending the repayment period, could make the loan more expensive for you in the long term because you’ll be accumulating more interest charges over time. Use a loan modification calculator to check how much interest rates you’ll accrue during the loan term and decide if it’s worth it.
- The process involved is extensive and time-consuming.
- The lender can deny your request for a loan modification.
- It will take longer before you become debt-free if the loan term is extended.
What Are The Qualifications For A Loan Modification?
The qualifications for a loan modification vary between lenders. In general, these qualify you:
- You’ve missed at least one payment and provided proof of financial hardship. It may be due to:
- Disability or illness
- Natural disaster
- Death of a loved one
- If you’re applying for a mortgage loan modification, your home must be your primary residence.
- Your current income cannot cover the repayment amount under your existing loan term.
When submitting a loan modification application, you have to provide the following documents:
- Completed loan modification application form
- Recent pay stubs
- Bank statements
- Tax returns
- Hardship statement (letter explaining your financial situation)
The lender will have 30 days from the day you submitted all of the required documents to respond to your loan modification request.
What Do You Need To Know Before Getting A Loan Modification?
Before you call your lender and ask for a loan modification, there are a few things you need to do first. You must:
- have a good reason behind the loan modification request
- be prepared to explain your current financial status
- explain any income you expect to receive in the future
- have a breakdown of your other financial obligations
- know how much you can afford as monthly payments
- never consent to an agreement that you don’t understand or can’t afford to pay
- remain calm even if things don’t go your way
If you’re seeking to have the terms of your current mortgage adjusted, you may qualify for a government modification plan, provided that the loan is backed by a federal agency or program.
If your mortgage loan is backed by Fannie Mae or Freddie Mac, you may be eligible for a Flex Modification, which allows adjustments on your mortgage terms depending on your type of financial hardship. To qualify, your mortgage must be at least one year old and you’ve missed payments or you’re facing foreclosure.
What Are The Dos And Don’ts When Getting A Loan Modification?
- Apply for a loan modification as soon as you know that you’re having trouble repaying your loan.
- Make sure to provide all the requested documents. One of the main reasons some loan modification applications are declined is the failure to submit all the requirements.
- Keep all correspondence between you and your lender. Store all written communications, such as the confirmation letter that your lender has received your application, in a safe place. Who knows, you may need it in the future.
- Send documents that are ineligible as this could lead to delays or even denial of your loan modification application.
- Lose your temper if the process doesn’t go as smoothly as expected.
- Be scared to ask questions or clarify things. You need to fully understand what you’re getting into, so make sure you ask if you have any questions.
- Forget to ask for an update. Lenders receive several requests and sometimes they may forget to give you an update about your application. Don’t hesitate to ask for the status of your request. This will help you determine if your application is on track and help you address any issue that may lead to delays in processing your application.
When Can Your Loan Modification Application Be Denied?
- Failure to meet the requirements. Before you submit an application, you need to know the lender’s guidelines for a loan modification.
- Failure to submit all necessary documents. Get a list of documents that you have to submit. Make sure to fill out the forms correctly and completely. All paperwork submitted must be legible.
- Failure to write a convincing and honest hardship letter. A financial hardship statement plays a crucial role in the approval of your loan application. You need to convince the lender why your request should be approved.
- New loan applications. Avoid applying for new loans. If you do, the lender evaluating your loan application may assume that you can’t handle your expenses.
These tips aren’t a guarantee that your loan application will be approved, but they can help increase your chances of getting a more favorable decision.
What Happens After A Loan Modification Is Approved?
Within 30 days since you submitted your application, your lender will notify you if you get approved. When it’s approved, you’ll be subject to a loan modification trial for 90 days, which means your lender will monitor if you have the capacity to pay the new loan terms. This is optional for private lenders, but for the government’s Home Affordable Modification Program (HAMP), it’s a requirement.
When you pass the trial modification loan, your lender will send you a permanent loan modification agreement. You need to sign the document and return it to the lender on the date they specified. You may also be asked to submit last-minute documentation, including proof of homeowners insurance. If you fail to return the signed agreement, your lender will cancel your loan modification. When your lender receives all the required documents and the signed permanent agreement, your loan modification becomes official.
What Is The Difference Between A Loan Modification And Refinance?
Loan modification and refinance are two different options you may consider if you’re struggling to pay back your loan. They provide similar results like lower monthly payments, but they have different requirements and processes.
Refinance A Loan
Refinancing a loan involves taking out a new loan to pay off your old loan from your current lender or a different creditor. Once approved and you’ve completed the closing process, you’ll make payments on the new loan under the new loan term or until you decide to have it refinanced once again. This option is ideal if you wish to have a better interest rate and repayment terms, or if you want to have a less risky loan.
Refinancing means you’ll be starting over on your repayments. It wouldn’t matter if you only have 15 years left to pay on the previous 25-year loan since refinancing resets the repayment count. It allows you to choose a loan term that will shorten or lengthen the period to pay off the new loan.
You have to pay the closing costs when refinancing a loan range from 2% to 5%. Furthermore, you need to have an excellent credit score and stable income if you wish to get better chances of refinancing your loan.
Unlike refinancing, a loan modification doesn’t involve taking out a new loan. As the name suggests, it involves making adjustments to your existing loan so that the payment becomes more manageable.
It can help prevent home foreclosure, making it an attractive option if you’re struggling to pay your mortgage. A loan modification doesn’t require you to have a good credit score or pay for expensive closing costs compared to refinancing a loan.
Loan Modification Vs. Refinance: Which Option Is Better?
Which is better—refinancing or loan modification? The answer to this question depends on several factors.
Refinancing is a good option if you have a good credit score, stable income, and updated loan payments. Since you’re taking out a brand new loan to pay off the existing one, you should be prepared to go through a tedious and lengthy process, from the loan application to the closing procedure.
Meanwhile, a loan modification involves less paperwork since changes will be made to your existing loan. It’s a good solution if you’re currently experiencing financial hardship and you’d like to make some adjustments on your loan term for relief.
A loan modification can benefit you in many ways. If you’re struggling to pay your debt because of financial hardship, you can submit a loan modification application to your lender. If approved, it will reduce your loan’s interest rate and monthly payments, or prevent foreclosure if it involves a mortgage loan. Just make sure that you know what you’re getting into before deciding to have your loan terms modified for there are both pros and cons doing this, as we’ve outlined in one of the sections above.