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What is a loan modification?

A "loan modification" is a change in the terms of a loan that is mutually agreed upon by both the lender and the borrower. Loan modifications are most commonly sought by homeowners that wish to modify the terms of their mortgage because they are behind and risking foreclosure. Since the housing crisis erupted in the US in 2007 the number of loan modifications has gone through the roof. Getting your loan modified can be a terrific way to prevent foreclosure and keep your home. So what's the downside? Not everyone qualifies for a loan modification and the big lenders in the US are overwhelmed with requests and are having a hard time keeping up (this means lots of consumers not getting phone calls returned etc...). For more information on how loan modifications work, see our article how loan modifications work.

Do loan modifications really keep people in their homes?

Getting a loan modification on your mortgage is a great way to keep your home if you are having trouble making the payments and you qualify for the modification. However, there are a few big questions that have not yet been answered - do loan modifications work over the long term? In other words, do people who get loan modifications keep their homes for a long period of time or do they end up in foreclosure a few months later? What percentage of homeowners who get loan modifications end up back in the foreclosure process? Since the massive increase in the number of loan modifications is a recent phenomenon there is not enough time tested data under our belts to fully answer these questions. A recent report by the OCC and OTS surveyed 133,000 loan modification recipients from the 3rd quarter of 2008 and found that within 6 months over half of the loans were 30 days or more delinquent and one third were 60 days or more delinquent. This report certainly suggests that loan modification is not working very well - is this the case? It's a complex situation and the answer is not that simple. In order to truly understand the situation you need to look at the different types of loan modifications that are available. Long term success of loan modifications seems to be directly linked to the type of loan modification that was done.

What types of loan modifications are available and which work the best?

Traditionally, the most common type of loan modification takes the total amount of delinquent payments plus delinquency fees and adds that to the principal balance of the loan. This essentially wipes the slate clean and allows the homeowner to move forward with no past due payments and penalties. The problem with this type of modification is that it does nothing to lower the monthly payments and make the home more affordable for the long term. This type of modification is preferred by the lender and was therefore commonly used in the early stages of the US housing crisis. Initial data (like the findings mentioned in the paragraph above) showing that loan modifications have a high rate of short term re-default is no doubt skewed by the fact that so many of the early loan modifications were the type that just removed late payments and late fees and added them to the principal balance. In early 2009 the Obama administration began pushing for modifications that would more directly benefit homeowners by lowering loan payments / interest rates and or increasing the term of the loan. A study by The Center for Community Capital at the University of North Carolina - Chapel Hill in March 2009 showed that the risk of a re-default is greatly reduced when a modification is done that achieves lower payments through interest rate reduction or term extension.

Given the seriousness of the current housing crisis it is safe to say that loan modifications are going to be happening with great frequency for the foreseeable future. If you find yourself unable to afford your monthly mortgage payment and fear foreclosure is looming ahead, then loan modification may be your best course of action. Keep in mind that early data is suggesting that the type of modification that is most effective at keeping you in your home for the long term is a significantly lower monthly payment achieved by interest rate reduction and or term extension. This is what you need to fight for regardless of what the lender wants you to do.