How Loan Modification Helps Lower Payments

Types of Loan Modifications

Blue ballpoint pen and a calculator on a loan agreement.
••• William_Potter/iStock/Getty Images Plus  

When your mortgage payments become a burden, sometimes a little break is all you need. Loan modification programs may provide the relief you need by making permanent or temporary changes to your loan. You don’t need to default on your loan entirely—you can make a few adjustments and get back on track without doing significant damage to your credit.

What Is Loan Modification?

A loan modification is a change to the terms of your loan, typically due to financial hardship. In most cases, the goal is to lower the monthly payment. Modification is an alternative to foreclosure, which is easier for homeowners and less expensive for lenders. You get to stay in your home, and your credit suffers less from modification than it would after foreclosure.

By changing terms of your loan, lenders can calculate a new monthly payment, and the amount should end up being lower.

Options for Loan Modifications

A modification can come in several forms. Some options are better than others, and your lender might not offer all of the options listed below (they might also have additional options). The best solution for you is a principal reduction, but that’s also the most difficult to qualify for.

Principal reduction: Lenders can eliminate a portion of your debt, allowing you to repay less than you originally borrowed. They also recalculate your monthly payment, which should be smaller. Lenders are typically reluctant to reduce the principal on loans. Instead, they’re more eager to change other features of your loan (which may result in more profit for them—not losses). If you’re fortunate enough to get approved for principal reduction, discuss the implications with a tax advisor before moving forward.

You may owe taxes on forgiven debt or see other complications.

Lower interest rate: Lenders can also reduce your interest rate, which reduces your required monthly payment. Sometimes those rate reductions are temporary, so read through the details carefully and prepare yourself for the day when your payment increases again.

Extended term: With a longer-term loan, you have more years to repay your debt. The result, again, is a lower monthly payment. But longer repayment periods usually result in higher interest costs, so you could end up paying more for your loan than you were originally going to pay.

Refinance the loan: Modification is typically an option for borrowers who are unable to refinance, but it may be possible to replace your existing loan with a brand new one. A new loan might have a lower interest rate and a longer repayment period, so you’d have lower payments going forward. Again, this option will likely increase your total interest costs, and you may have to pay closing costs to refinance.

Convert to fixed-rate: If your adjustable-rate mortgage is threatening to become unaffordable, you can prevent problems by switching to a fixed-rate loan.

Postpone payments: You may be able to skip a few loan payments. That might be a good solution when you're in-between jobs (with a paycheck on the horizon) or you have surprise medical expenses. You'll have to make up those payments at some point though. Your lender adds those missed payments to the end of your loan, which means it will take a few extra months to pay off the debt.

To see exactly how your payment changes when you use any of the strategies above, get into the numbers. Learn about the process of paying down loans (also known as amortization) or start punching numbers into a loan amortization calculator.

How to Get a Loan Modification

To get your loan modified, apply with your lender. Start with a phone call or online inquiry, and let your lender know about your financial situation. Just be honest and explain why it’s hard for you to make your payments.

Lenders will require an application and details about your finances to evaluate your request. Be prepared to provide the following information.

  • Income: How much you earn, where it comes from, and more
  • Expenses: How much you spend each month, and how much goes toward different categories (like housing, food, and transportation)
  • Documents: Proof of your financial situation, including paystubs, bank statements, loan statements, and other important agreements

The application process can take several hours. You’ll need to fill out forms, gather information, and submit everything in the format your lender requires.

Timeline: Lenders may take several weeks before they provide an answer, and it may take even longer to change your loan—assuming you get approved. During that time, it’s often best to do what your bank tells you to do (unless you have reasons for doing something else). For example, if they instruct you to continue making payments, doing so should help you qualify for modification.

Lenders have different criteria for approving modification requests, so there is no way to know ahead of time if you’ll qualify. The only way to find out is to ask.

Government programs: Depending on the type of loan you have, it may be easier to qualify for loan modification. Government programs like FHA loans, VA loans, and USDA loans offer relief, and agencies can also help. Speak with your loan servicer or a HUD-approved counselor for details. For other loans, try the Fannie Mae Mortgage Help Network.

Why Lenders Modify Loans

When you stop making mortgage payments, lenders have several unattractive options. They can:

  • Foreclose on your home (force you and your family out, and sell the property)
  • Attempt to collect money you owe through wage garnishment, bank levies, or collection agencies
  • Accept the loss and write off the loan as a loss
  • Lose the ability to recover funds if you declare bankruptcy

None of these options are appealing to you or your lender. They damage your credit, and those approaches are expensive and time-consuming for lenders. Banks are not in the business of managing property, and you'd probably prefer not to move your belongings or your family to a new home.

Mortgage Modification Scams and “Helpers”

Unfortunately, homeowners in distress attract con artists.

When you’re searching for solutions, beware of promises that sound too good to be true. To be safe, it’s best to work directly with your lender. Your lender can change your loan, and that’s the organization that reports to credit bureaus.

Some organizations promise to help you get approved for a loan modification. They may (accurately) explain that lenders don’t always know about all of the options available to you, and they might not put your interests first. If you need help, you have the option of paying somebody to help, but those services come at a steep price—and you can do everything yourself if you have the time and energy to do so.

Whether you pay somebody or do everything yourself, you still need to do the work of gathering documents and details required for your application.