When foreclosure seems imminent, a loan modification seems like a godsend. A loan modification lowers your monthly mortgage payment by extending your loan, lowering the interest rate, reducing the principle on the loan, or a combination of all these things. The benefit is a mortgage payment borrowers can afford, but the true cost, many are discovering, is a damaged credit score.
Why a loan modification hurts your score
The problem lies in the way loan modifications are reported to credit bureaus. Anytime you don’t pay your accounts as originally agreed, your credit score usually takes a hit. This is what happens with a loan modification. A loan modification is often reported as a settlement or renegotiation of loan terms, which credit scoring models view as negative. Future lenders want to know if you didn’t pay an account according to the original terms and credit scores take that into account.
How a loan modification can hurt your score
This lowered credit score takes many by surprise. In fact, some borrowers were told there would not be any adverse effects from the loan modifications. For example, Howard Spindel had been assured nothing negative would happen to his credit as he was signing up for a mortgage modification. It’s Only Money says that months later, two of Spindel’s credit cards were cancelled and creditors cited delinquencies on his credit report as the reason. Turns out the loan modification reported his payments as delinquent during a 3-month trial period.
Victor Stern of Charlotte, North Carolina saw his credit score drop 121 points from 740 to 619 after singing up for a loan modification, reports Bloomberg News. Stern had never been late on mortgage payments.
Foreclosures and loan mods alike can damage credit
Borrowers seek out loan modifications because they don’t want the stigma of a foreclosure haunting their credit reports for seven years. Unfortunately, they’re not much better off considering the way loan modifications are reported.
Designed to help, not hurt, our economic recovery
The loan modifications are part of the Making Home Affordable program signed by the Obama administration to get the housing market back on track. The program begins with a three-month trial period during which borrowers make reduced payments before receiving a loan modification. During the trial period, borrowers make the reduced mortgage payments. However, these reduced payments are lower than the minimum mortgage payment and are sometimes reported as late payments.
Federal guidelines require lenders to report timely payments if the borrower was current on payments before applying for the program. It seems some lenders aren’t completely aware of those guidelines and one member of the Credit.com forum comments she was able to get her lender to report payments correctly by simply sending a copy of the program guidelines (information about credit bureau reporting can be found on page 22 of the Home Affordable Modification Program administrative guidelines).
Unfortunately, if you were delinquent on mortgage payments before entering the modification trial period, your payments will continue to be reported as late. Also, creditors are still allowed to report your mortgage status as “settled” or “not paid as agreed.” Both listings will likely impact your credit score.