Sense & Centsibility Blog
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Avoid Foreclosure; Get a Loan Modification

In a previous blog post, I listed several options that your mortgage lender might offer if you are behind on your payments and trying to avoid foreclosure. Of those options, a loan modification is often the most effective and common tool offered. It gets monthly payments back on track and keeps those payments affordable.

This blog post explains the loan modification process. In writing this, I made several assumptions.

  • This information pertains primarily to homesteaded residential properties in the state of Minnesota.
  • A homeowner is dealing with late mortgage payments for the first time and intends to keep the home.
  • None of the following information is legal advice. Be sure to consult with a reputable attorney regarding bankruptcy or other legal questions.

Working with Loss Mitigation

If you request a modification, the loss mitigation department at your mortgage company typically works with you. You will fill out an application for mortgage assistance, generally called the “loss mitigation packet.” It might also be called the “borrower assistance form,” “workout packet” or “hardship packet.” The mortgage company usually requests your most recent pay stubs and bank statements. It also asks for copies of one to two years’ worth of tax returns or gets your permission to pull your most recent returns.

Fill out the paperwork thoroughly, and send loss mitigation the requested information promptly. Then check in with them regularly to make sure they have everything they need.

Factors that make modification more likely and less likely

  1. To receive a modification, you generally have to show that your current financial difficulties will improve in the future. Say, for example, you suffer an injury or have a medical-related incident and miss payments as a result. You later recover and are now back to work. In this case, there is a good chance that the lender will modify your loan.
  2. Your chances decrease significantly if you are in a deep, lasting financial crisis or hardship or there is no evidence of a current, stable income. This includes using unemployment benefits, since they are considered temporary income. Even the promise of future income (e.g., being hired for a new job or working on a project for which one will be paid down the road) is not enough; you have to produce actual pay stubs first.
  3. Housing ratios can play also a large role. This ratio is the monthly mortgage payment divided by the homeowner’s gross income. Historically, the Home Affordable Modification Program has established a 31% mortgage payment-to-income ratio as a benchmark when modifying mortgages. If the ratio is under 31%, the lender could assume that you can afford to make normal monthly payments. Instead of receiving a modified loan, you will instead have to reduce spending in other areas to afford the mortgage payment. If your ratio is above 31%, it might be evidence that the mortgage payment contributes to your hardship, and you will more likely receive a modification.

Capitalization

Each mortgage payment that you miss will be added to a past-due amount. The total past-due amount will often be “capitalized.” This means that past-due payments are added to the principal balance of the mortgage, and the total mortgage amount increases. Forgiveness of any of the outstanding debt is rare.

Escrow shortage

When property taxes and homeowner’s insurance are included in the monthly mortgage payment, they are placed in an escrow account. When a homeowner misses payments, the mortgage company will often keep paying into the escrow account on the homeowner’s behalf, especially property taxes. The result is an escrow shortage, which the homeowner must pay back.

If your homeowner’s insurance policy lapsed because you missed payments, the mortgage company will often put you in a “force-placed insurance” policy to replace your lapsed policy and keep your house insured.  Force-placed insurance is often considerably more expensive than the standard homeowner’s policy. Thankfully, you can (and should) replace the force-placed policy with your own insurance if and when the mortgage is modified.

Ways to keep payments affordable

A loan modification isn’t very effective if you become current on your mortgage, but your payments aren’t affordable. Therefore, sometimes the mortgage company lowers the interest rate on the mortgage.

The company might also extend the date when the mortgage is scheduled to be paid off, officially called a “term extension.” Some homeowners may be concerned about a modified mortgage with a new 30-year or even a 40-year term. However, this extension will help you stay in your home and keep your payments affordable. You can always make additional payments toward the principal, which will reduce the mortgage term.

After a modification, the mortgage company might request that you pay the escrow shortage in full. It is often difficult to afford a large lump sum payment, so mortgage companies often allow you to pay back the escrow shortage over a period of 60 months.

Pre-trial and final loan modification

If you have gone through all the above steps, and loss mitigation determines that a modification could get the mortgage back on track, there is often a “pre-trial” period. This is a specific time frame, typically three months, in which you must make the new payment that loss mitigation determines. It is a test to see that you can resume making mortgage payments.

Making on-time pre-trial payments is crucial to finalizing your loan modification. Should you fail to do so, the loan modification process might start all over, and there is no guarantee that the mortgage company will again offer this option.

After you make the last pre-trial payment, you will receive a final modification contract to sign and date. It can take a little time to process, but if the modification is successful, you should start receiving monthly statements again showing the new payment amount. With continued on-time payments, your credit report will soon show the mortgage as current. Most importantly, your house is no longer at risk of foreclosure.

The modification process is sometimes frustratingly slow. Remain patient yet vigilant in communicating with the loss mitigation department throughout the process.

Get the support you need

LSS Financial Counseling is here to help Minnesota residents with free, expert foreclosure prevention counseling and advice. If you live in MN and are worried about your mortgage payment, call 888.577.2227 to schedule your free phone session or ask any questions

If you’re outside of MN, go online to find a HUD-approved, local counseling organization. Keep in mind that all HUD-approved counseling is free. Never pay for help with your mortgage.

This article is the second in a three-part series on foreclosure prevention. In part three, I will talk about the foreclosure process itself as well as strategies to slow down the process.

Author Dan Park is a Certified Financial Counselor with LSS Financial Counseling.