The news is filled with talk about loan modification and President Obama’s Making Home Affordable plan, and in a nation where over 3 million people are past due on their mortgage payments, a solution to their woes is something worth talking about. Loan modification is being pitched as a way to help troubled homeowners reverse their progression toward a short sale or foreclosure.
While loan modification may be a perfect recourse for some, it should be noted that not all homeowners will qualify for a loan modification and even then, some who do would be better served pursuing a different option.
In order to qualify for a loan modification your mortgage must have originated before January 1, 2009, you must live in the home, your monthly mortgage payment must be more than 31% of your pretax income, you must prove financial hardship, and the amount you owe on your home cannot exceed $729,750. If you do qualify for loan modification, your loan servicer will reduce the interest rate on your mortgage until your monthly payments drop below the 31% threshold. This new interest rate can go as low as 2% but if that is not enough to get below 31% they may extend the life of the loan or offer to defer a portion of the amount you owe until the loan matures.
If these modifications are still not enough to make your payments manageable given your current income, then loan modification will not be an option. On top of that, because a loan modification gets reported to the credit bureaus as a seriously negative item that can drop your credit score by a hundred points or more, loan modification may not be the best option for you.
Because interest makes up such a large portion of monthly mortgage payments, simply lowering the interest rate often times is enough to make payments manageable. A loan modification does this for you, but if your credit score is still excellent, a traditional refinance may be a better option. Getting approved for a loan is much more difficult than it was just a few years ago, but if you can get approved, interest rates today are exceptionally low which can make a big difference. On a $250,000 30-year loan, reducing your interest rate from 8% to 6% would lower your monthly payments by over $300. When budgets are tight, $300 may be enough to steady your finances and help avoid the possible consequences of lowering your credit score such as difficulty getting approved for credit in the future, increased credit card interest rates, increased car insurance rates, and having a harder time finding a new job.