Understanding the Loan Modification Process

By J.D. Koontz

Debt is a part of modern life, from mortgages to purchase your home to loans for vehicles, property improvements, businesses, and more. We all know sensible borrowing means ensuring that repayments are affordable, and when applying for a loan of any kind, your lender will consider your ability to repay the proposed debt. Of course, the affordability should also be considered by anyone taking out a loan, too, avoiding adding new debt when possible. But this determination of loan affordability only considers the financial situation of that one point in time. Depending upon the loan type, a loan repayment term can stretch to thirty years. 

Loan repayment can become an issue, what is affordable today can become a financial burden down the road, and as we have seen with current events, that change can come very quickly and unexpectedly. But how do you deal with loans that, through unforeseen occurrences, have become unaffordable? The answer is not to ignore them, to hope that things just work out, or to suffer and worry in silence. Instead, be pro-active, get in touch with your lender or mortgage servicer to discuss the situation, because they might be able to help.

Loan Modifications

Loan modifications are an adjustment to the terms of a loan or mortgage to address changes in circumstances that make the current terms unaffordable or otherwise problematic. You may be eligible for a modification if you are in one of these situations:

• You are not able to refinance
• You are facing a long-term hardship
•  You have accrued significant mortgage arrears, or are in a position where arrears are inevitable

If you can, it is essential to take steps to ask about loan modification options before you become past due. Reaching out to your lender or loan servicer can save undue stress for you and provides an easier route to a suitable modification in the long run, too, if you qualify for a modification. This means accepting there is a problem early and being proactive with your outstanding debt rather than avoid dealing with it as some try to do, makes finding a solution much more manageable.

Loan modifications can take several forms, including:

• Interest Rate Reduction – By lowering the loan or mortgage rate, the payments are reduced. This can be a temporary arrangement, so be aware of the higher payments returning at some point in the future.
• Forbearance Plans – This process allows a borrower to make smaller payments or even no payments for a specific period. At the end of the forbearance period, the borrower pays the missed payments, which is dictated by a pre-agreed upon repayment plan or modification.
• Repayment Plan – past due payments are added to future loan payments for a predetermined number of months to bring the loan current. This allows the borrower to bring the loan current without making one large payment that may not even be possible.
• Short Sale – This is an alternative to foreclosure. A short sale allows the borrower to sell their home for an amount that is less than the outstanding balance of the loan. Depending on the situation, the borrower may still be responsible for some or all of the remaining loan balance. This allows a borrower a way out of the home without facing foreclosure. 
•  Reduction of the Debt – The least likely option that reduces the amount you owe. The payments are then re-calculated based on the lower debt, so you pay less each month. Debt forgiveness is a very unlikely option and may only be considered as a last resort by your lender or mortgage loan servicer. 
• Deed-in-Lieu – This is a way to avoid foreclosure by voluntarily conveying ownership of your home to the lender. The borrower may still be required to pay off any deficiency if the home value is less than the outstanding loan amount.

What type of loan modification is right for your needs, and which you are eligible for or offered by a lender, will depend on the type of loan, the reasons for seeking the loan modification, the future financial situation you expect, and what options are available to the lender or mortgage servicer. Your lender or mortgage servicer will work with you to develop a modification solution that fits both your interests and allows you to continue to make payments on the outstanding debt while also being mindful of their regulatory requirements or investor guidelines. The goal is to reduce the payments to an affordable level and allow you to remain current on your loan if possible. If it is not possible to stay in the home, there are options to enable you to transition out of the house.

Why use a Loan Modification?

Loan modifications are attractive, not just for anyone in difficulties with debt, but for lenders too. For the borrower the benefit is obvious if you find yourself in a position where through no fault of your own, your financial situation means that the loan payments are simply unaffordable, then rather than end up with judgments, liens, a damaged credit report, and foreclosures, you are able to maintain your property at a more affordable payment.

However, and this is especially for the types of loan modifications that cut overall repayments so lowers the amount the lender or servicers collects, you may wonder why a lender would agree to this solution. The reality is that foreclosures and other financial and legal solutions are time-consuming and expensive to administer. In the case of foreclosures, lenders and mortgage loan servicers are left with an asset to dispose of, your home, which in many situations is unlikely to repay the outstanding obligation. Also, a borrower declaring bankruptcy during the life of a loan can stall things indefinitely, causing the lender to incur legal expenses to protect the collateral, and even prevent the lender or servicer from taking control of the asset in question to repay the debt.

A loan modification enables payments to be maintained, albeit at a reduced level, is much less costly to manage and can be achieved quickly. Additionally, there is much less stress placed on the borrower, which in challenging financial times can be a boost to the lender in terms of brand perception. Helping people rather than making them feel punished amid an economic collapse can be a benefit to the business by creating loyal customers.

How to Seek a Loan Modification

It is clear that there are real benefits to be gained from a loan modification, and if you find yourself in a difficult financial position, as many do, it is a great option. But how do you get a loan modification if you need one?

The first thing to do is get in touch with your lender or mortgage loan servicer. It is important is to be upfront and honest about the situation and why you are unable to afford the current loan payments. You should also be realistic about the level of payment you could continue to make. If the lender is open to using a loan modification, they will ask you to complete a loss mitigation application along with details about your current financial situation. The application process could include but not necessarily limited to:

• Your Current Income – Including total earnings and where it comes from
• Your expenses – This includes your bills of course, but also other debt payments and essentials such as food and transport
• Proof – You cannot just claim income and expense levels, you will need to back this up with documentation such as pay stubs, tax returns, and other financial documents.
• IRS Form 4506-T – This form allows your lender to gain access to your tax information from the IRS.
• A detailed explanation – Sometimes called a hardship letter, this is your chance to explain the situation in detail. This includes what led to your financial problem and what you plan to do to deal with the situation. Remember, the information here should be backed up by the financial information and documents also provided.

Unfortunately, this is a complex process, and there is no getting around it. Take your time when completing the application, make sure you have all the documentation needed, and put everything together carefully to ensure that you have not forgotten anything. Lenders could potentially reject your application if you fail to provide specific information or deliver out of date documents by mistake. Also, keep a photocopy of everything you send so that you can easily reference it if there is a question. If you send documents by email, save the emails in a folder for easy reference.

Unlike checking credit scores to get a good idea about the kind of loan you can take out, there is no easy measure for the borrower to know if their request for a loan modification will be successful. Once the loss mitigation application is complete and submitted, the wait begins.

During that wait, it is vital to maintain contact with the lender as they may want to ask questions about your application or ask you to keep your current payment schedule during the application process, which, if requested, you should find a way to do.

Most lenders or mortgage servicers will get back to you within a timely manner, and if successful, they will usually provide written details of the proposed loan modification. You will then be given a set timeframe, to accept or reject the proposed modification. This process is not a negotiation, though, so rejecting it will likely mean no alternative is offered.

Government Loan Modification

If your loan is provided by a government-backed lender, there could be government programs that can help. Fannie Mae has combined the features of the Home Affordable Modification Program (HAMP), which expired in December of 2016. Their Standard Modification and Streamlined Modification into the Fannie Mae Flex Modification program offers mortgage loan servicers a program that takes advantage of lessons learned from the past.[1]

Freddie Mac has recently announced assistance to borrowers affected by COVID-19.[2] This includes,

• Providing mortgage forbearance for up to 12 months
• Waiving assessments of penalties and late fees
• Halting all foreclosure actions and evictions of borrower living in Freddie-Mac owned homes until at least May 17, 2020
• Offering loan modification options that lower payment or keep payments the same after the forbearance period.

Loan Modification Issues

There are issues to be aware of when considering a loan modification as an answer to a difficult financial situation. From the application itself to assessing the offer, there are some challenges that need to be considered.

Intermediaries

The application process for a loan modification can seem daunting, and it is perhaps unsurprising that there are many companies out there that offer to do it for you, usually for a fee. However, what they are doing for a fee is asking you for the documents that the lender asks you for, and then submitting them on your behalf. Instead of relying on others, work through the application and collect the information requested. Do this methodically, check carefully and make copies of everything you will be submitting.

Documentation

It is crucial that you provide all the required documentation with your loan modification application. One of the biggest causes of rejection is missing or out of date documents. In addition, to pay stubs, you will most likely be asked to fill in IRS Form 4506-T and include it with your application. The IRS Form 4506-T allows the lender to access the relevant tax information directly from the IRS itself, ensuring that you provide the up-to-date information they need.

When completing the application, take care to include everything, double and triple check the application, and make sure each piece of information, signatures where necessary, and the supporting documents are included.

Capacity

In times of severe economic downturn, when it is most likely the idea of loan modifications will be considered, there can be an issue with the capacity of lenders to help people in time. As we have shown through the application process, applying for a loan modification can be a daunting task for some, and requires significant time by the lender or mortgage servicer to process each application by hand. This can mean that lenders and servicers can become overwhelmed if not properly staffed with large numbers of applications in a short period of time, leaving some borrowers waiting too long and struggling with the pressure of debt.

If you are facing any issue with payments, you should always take the initiative and get in touch with the lender or servicer as early as possible to give time to sort any potential solutions before payments fall further behind and become even more challenging to make.

If a borrower feels that they have been treated unfairly during a loan mitigation process, they may seek redress through the courts. These cases often utilize an expert witness in abusive, unfair, and deceptive loan practices. A loss mitigation expert witness with an understanding of the loss mitigation procedures and practices can be retained to investigate and offer opinions as to whether or not the alleged conduct was improper.

 Conclusion

When financial catastrophe strikes, from job losses to being furloughed with reduced or no pay, it is crucial to take control of the situation rather than let it overwhelm you. If you know payments are going to be a problem, do not wait until you fail to make one, and the collection letters and calls begin, be proactive and get in touch with the lender first and explain the situation.

For many, a loan modification that reduces their loan payments to a more manageable level can be a great option, avoiding distressing, life-changing consequences such as foreclosures while also enabling continuing, affordable payments that match your new situation. They are not a solution for every problem, but for many, a loan modification is a lifeline you need to avoid severe financial challenges.

[1] Fannie Mae Flex Modification Fact Sheet. https://singlefamily.fanniemae.com/media/9016/display

[2]  https://www.freddiemac.com/about/covid-19.html