A loan modification is a mutual agreement by the lender and the borrower to change in the terms of the loan so that the loan is more affordable to the borrower over the long term, so the borrower can stay in their home. A true loan modification is a permanent solution that serves the best interests of the investor who owns the loan as well as the homeowner. It's not supposed to be a short-term solution like a repayment plan or forbearance.
Loan modifications are not refinances. They are simply renegotiations of the terms of an existing loan, so the qualification process is not the same as it is for a refinance. Some say you don't need an appraisal, but it's best to get one especially in light of declining home values. An appraisal can help you convince the lender that it's in their best interest to take your loan modification proposal, especially if your house has decreased in value.
No two loan modifications are the same. They depend on a variety of circumstances and can consist of a reduction in the interest rate, a change from fully amortized to interest only payments for 5 to 7 years, a freeze on interest rates for 5 to 7 years, an extension of the loan term, a reduction of the principal balance of the loan, and a resolution of any arrearages (usually by adding them to the loan balance). This article discusses some of the pros and cons of loan modifications.
Loan modifications are time-consuming.
Typically, your lender will make you wait 30-45 days before your ARM is up in order to even submit an application. And, just because you submit an application does not mean you'll qualify for a loan modification. Loan modifications take a long time to complete, and you may end up falling even further behind on your payments. This could seriously increase the threat of foreclosure and disqualify you from a loan modification. If the lender feels they will take too big a loss, they won't approve your proposal.
Fixed Rate Mortgage versus Flexible Rate Mortgage
Most people know what a fixed rate mortgage is: a type of mortgage where you need to pay a fixed interest rate each month to pay off your home loan for a specified period. Flexible rate mortgages, also known as adjustable rate mortgages (ARMs) have rates that change according to the money market conditions. Getting a loan modification will not necessarily change your ARM to a fixed rate mortgage. The terms may only change to where your rates freeze for an extended period of time or you end up temporarily paying interest only. Then, you're subject to whatever money market conditions prevail when your rates get ready to reset.
FHA may be a good option if you don't qualify for a loan modification.
Loan modifications will require that you have a high debt to income (DTI) ratio. This is why it is important to get an appraisal on your home. It could have declined enough in value for you to qualify. However, if you don't qualify because your DTI isn't high enough, you may want to consider a FHA loan.
With a FHA home loan, not much equity is needed. It's also a fixed rate mortgage with low interest rates. But, the cons are mortgage insurance. FHA charges an upfront mortgage insurance premium plus a monthly premium. A loan modification wouldn't require that.
Loan modification companies tend to charge high fees.
If at all possible speak with your lender first. If they are unresponsive or are otherwise unable to help, seek legal counsel with a real estate attorney that specializes in loan modifications. You'll have to pay the attorney fees, but at least you'll know for certain that the attorney will represent your best interests. And, the attorney may be able to find unexplained fees charged in your loan, Truth in Lending Act (TILA) violations or RESPA violations, which could provide a valuable bargaining chip in your negotiations--both in qualifying for the loan modification and in how much you end up paying. If your rights as a borrower were violated when you were refinancing, consider contacting lawyers that specialize in predatory lending abuse.
Most lenders do not want to lose your money, so they will generally work with you. But, you have to be proactive in contacting them and be persistent. Do not wait until the last minute. The quicker you contact them and explain your circumstances, the quicker you can get your application under way. Try to lock in an interest rate before your rates increase. Loan modifications are a good option, and you could save your home from foreclosure. If you are having difficulty with your lender, contact us. We may be able to help.