Simple Explanation of the Mortgage Modification Process

If you are up against foreclosure, or have a mortgage payment that is too high, then you've probably thought about getting a loan modification. A loan modification is when the terms of a loan are permanently modified to allow a reduced payment.

The lower payment is delivered by either lowering the interest rate, extending the term, or reducing the balance to be more in line with the current market value. In most cases, a combination of several of these methods is used to lower the loan payment. There are other alternative ways to lower a payment with a modification too, but they all revolve around the term of the mortgage, the payoff, and/or the interest rate.

Here is an uncomplicated example of how a loan modification can reduce the payment, using each of the three methods above.

Method #1 - Reducing the interest rate

Lets assume the mortgage balance is $200,000 and the current interest rate is 7.75% and the payment amount is $1,750. Lets also assume this homeowner has 20 years left on a 30 year mortgage. The homeowner can no longer afford this payment because of a job loss. They can afford a $1,250 payment, so the bank agrees to reduce the interest rate to a fixed rate of 4.25% for the remaining life of the loan. This will give them a payment of $1,240, without the need to lengthen the term of the loan or lower the payoff amount..

Method #2 - Modifying the term of the loan

Lets use the same example above, only this time, we'll assume the homeowner can afford a $1,500 payment. The loan amount will still be $200K and the interest rate will still be 7.75%. But in this scenario, the servicer was not willing to reduce the interest rate. This happens quite often, because the investors on the loan are not willing to accept a reduced rate. In this scenario, extending the length of the loan will make the payment affordable again and the investors will keep their 7.75% interest rate. The $200,000 payoff is re-amortized over a 30 year term to get a reduced payment of $1,430. Everyone is happy because the foreclosure was prevented and the new payment is affordable.

Method #3 - Reducing the payoff amount

In order for a payoff amount to be dropped, the value of the house must be less than the payoff amount. In a few cases, lenders will lower the payoff amount without this stipulation, but it's highly doubtful. To get the payoff amount dropped, you must prove to the underwriter that foreclosing on the house will cost more than lowering the payoff to make the loan affordable again.

In this scenario, we'll assume the home's current market value has been established at $179,000, but the amount owed is still $200,000. If the bank forecloses on the home and tried to sell it, their estimated loses will be 30% of the home's value. So after foreclosing on the home and re-selling, they will net around $125,000, if they are lucky. Most banks expect to lose 30%-60% on every foreclosure property, so this amount is being very generous.

By letting the current owner to keep the house, with a new affordable payment, they can continue servicing the loan and collect the full value, plus interest. This is a much better option for the lender, assuming the new payment is affordable. By reducing the payoff to $179,000 and keeping the same interest rate and 20 year term, the new payment is $1,470, which now fits into the homeowners $1,500 budget.

Attempting All Three Solutions At Once

When working on my personal cases, I often try to get the lowest possible payment, which would mean lowering the interest rate and payoff, while lengthening the mortgage to 30 years. By negotiating all of these figures, a new payment of $880 could be fixed for the remaining term of the loan. An experienced loan modifier knows exactly how to get the lowest possible payment in the shortest amount of time.

Negotiating with investors is all a matter of having the right knowledge and being prepared. It's not something most people can achieve without help, regardless of what many people may think. A loan modification is the answer to keeping and affording your house. Presenting your case without experience can not only cost $1000's but it can cost you your home!

In the example above, the difference between a good modification and a bad modification adds up to over $100,000 in extra payments over the life of the loan! So even if you are successful with a modification without help, it could still cost you over $100,000! If you don't completely understand what you're doing, or don't have confidence in your ability to get an affordable payment, make sure you employ someone to help immediately. There is no time for "learning as you go" when a single error could cost you your home!