What Is a Modification Loan?

A loan modification involves the mortgage lender working with the borrower to change the terms of the original loan. The "modifications" may include lowering the interest rate, altering the term of the loan, reducing the principal or changing other provisions of the original agreement. Loan modification is typically designed for homeowners who are dealing with severe financial hardship and cannot make their mortgage payments.



Homeowners have trouble making their loan payments for a variety of reasons, including unemployment, underemployment, divorce or disability. When faced with financial challenges, borrowers may be able to work with their mortgage lenders to alter the terms of their original loan. The purpose is to temporarily or permanently make changes that will lower the borrower's mortgage payment to a specific percentage of the homeowner's monthly income, which is usually 31 percent. This will enable them to stay in their home and avoid foreclosure.


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Loan Modification Program

The United States Treasury Department's Making Homes Affordable loan modification program applies to first mortgages on primary residences. The loan must have been originated before 2009. The mortgage must be on a single-family home with a maximum unpaid balance of $729,750. The borrower must be able to demonstrate financial hardship, such as a job layoff, overwhelming medical bills, an adjustable rate that is about to kick in and increase your mortgage payments, or any other reason that would make it a hardship to meet your mortgage obligations.



The objective of the Making Homes Affordable loan modification program is to bring your monthly mortgage payments to 31 percent of your gross monthly income. The federal government's loan modification works like this:

1) The lender agrees to lower the interest rate to as low as 2 percent. It may also extend the term of the mortgage to as much as 40 years. The aim is to reduce the monthly mortgage payment to below 38 percent of the homeowner's monthly income.


2) The United States Treasury will step in and match any additional reduction, dollar-for-dollar, with the mortgage lender, with the objective of reducing the new mortgage payments to 31 percent of the homeowner's monthly income.

3) As an incentive, homeowners who make their new payments on time will receive a maximum of $1,000 each year from the government; it will be applied toward their mortgage principal.

4) After five years, the lender is allowed to raise the interest rate on the loan. However, it cannot exceed 1 percent a year and the overall interest rate cannot exceed the prevailing market rate as determined by Freddie Mac at the time the loan modification was made.



Many borrowers obtain legal counsel or help from nonprofits or for profit loan modification companies. Some choose to do it themselves. Whichever route you choose, you need to gather the following information to help smooth the application process: proof of your monthly gross income; your most recent tax returns; current checking and saving account statements; 1099 statements and documentation on assets; mortgage documents; balances and payments on credit cards and other installment payments; information on other debts, such as automobile and student loans; and a hardship letter explaining any circumstances that affect your situation.



There are basically four options for presenting a loan modification proposal to your lender: hire a lawyer, pay a fee to a loan modification company that will do the work for you, find a low-cost nonprofit organization to assist you, or do the loan modification yourself.