How Loan Modifications Work

Loan modifications have been a part of a bank's repertoire since the introduction of mortgages. Historically, if interest rates dropped a borrower could contact their bank and ask for a modification of their loan instead of a refinance. A modification simply changes parts of the note, in this case the interest rate, and the lender keeps the mortgage. A refinance pays off the old mortgage completely, typically with a brand new lender.

As banks found their mortgage holdings becoming more and more delinquent and foreclosure rates on the rise, they began to solicit their borrowers offering a loan modification.

A loan modification works similarly to a refinance or any other mortgage application yet with much less paperwork. A loan modification will typically require:

  • Most recent bank and investment statements
  • Most recent paycheck stubs
  • A hardship letter requesting the modification
  • A signed modification application

When a homeowner applies for a loan modification, the lender evaluates the current income situation, assets and credit report. The lender can then determine the new interest rate, dropping it low enough to meet standard debt ratio guidelines.

The lender will determine affordability by comparing current debt and the new mortgage payment with current, verified income. Many lenders won't modify a mortgage however if the mortgage is more than 90 days late.

If the loan modification does get approved, the homeowner makes the new mortgage payments based upon the new, lower amount.

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