How Loan Modification Works

Introduction

When jobs are lost, economic hardships occur, or financial situations change, sometimes paying a mortgage payment can be difficult. Unfortunately, many people in this position end up in foreclosure due to inability to pay their mortgage. To avoid foreclosure, lenders may offer a loan modification. According to the U.S. Department of Housing and Urban Development, loan modifications are permanent changes in the terms of a loan, allowing you to more easily afford your monthly payments and avoid foreclosure.

Principal

One way a loan may be modified is through a reduction in the principal of the mortgage. Your principal is the amount of money still owed on the loan, minus the interest that has accrued over the history of the loan. Lowering the principal allows the lender to lower your monthly payments to reflect the new balance.

Interest Rate

Interest rates may also be lowered during a loan modification. Higher interest rates can dramatically increase the total cost of your loan over the long run. Your lender may offer to lower the interest rate on the outstanding balance of your loan during a loan modification, which, in turn, can lower your monthly payment.

Term of Loan

Another way a modification may make your loan more affordable is through extending the term of your loan. The term of your loan is how long you have to pay your loan off. The longer the loan term is, the more months the monthly payment is distributed over. Extending the loan term lowers your monthly payment. On the other hand, it’s important to remember that extending the term of your loan also increases the amount of months you are paying interest on the loan. This can increase your final cost of the loan.

Penalties

During a loan modification, your lender may also cancel penalties on your account, such as past late fees. This can temporarily lower the amount of money you owe on the loan, reducing your total monthly costs, and making your payments more manageable.