Definition
Loan modification is a special arrangement in which the original mortgage contract is revised into a new contract that allows the borrower to better afford the loan payments.
Analysis
Loan modification is encouraged by the U.S. Department of Housing and Urban Development (HUD) as a way for homeowners and lenders to avoid foreclosure. It can allow a distressed homeowner to remain in a home if they can find away to afford the mortgage through restated terms.
The elements of loan modification can include:
- longer duration
- lower interest rate
- fixed interest rate
- greater than 100% loan-to-value (LTV) ratio is possible
- different type of loan
- loan reinstatement must be included
A loan modification is preferred over a forbearance when the homeowner needs a permanent resolution to their problem. Lenders may prefer either option depending on the situation over foreclosure, since foreclosure includes substantial costs that the lender likely will not be able to recover.
Homeowners must meet certain eligibility requirements in order for a lender to consider loan modification. These include:
- property must be maintained
- borrower must reside at the property
- property cannot be in foreclosure
- loan must be at least 1 year old
- borrower must be at least 90 days delinquent
- loss of income or increase in expenses must be verified
- borrower can reasonably afford the new loan payments
HUD may provide $500 to the lender as an incentive to modify the original loan, plus an additional $250 to reimburse for title documentation expenses.
