Loan modification – is the lower payment worth it?

If you’re like an increasingly large number of Americans, you’ve recently received a letter from your bank. And if you’re lucky, it’s not a notice of foreclosure--it’s a letter announcing an offer for a loan modification. The banks are handing these things out like candy these days, and most people, especially those with banks that already have a tendency to try to upsell to their customers, are suspicious.

A lot of these loan modifications include options to switch an adjustable-rate mortgage (ARM) to a fixed-rate mortgage, partial debt forgiveness, and other bells and whistles. And, while the banks are not doing this out of some sudden bout of philanthropy, many unsolicited loan modifications are a good deal for both parties. Before we continue, never ever assume that all loan modification offers come from reputable sources because most are paid advertisements. There are scammers out there that will take you for all your worth if you aren’t vigilant. Real loan modification offers should come from the bank that handles your mortgage.

Banks are trying to get ARM loans out of their systems--they’re far more likely to end in default than fixed-rate loans and the government views them as “toxic assets”, which in turn can affect how the government and investors deal with the banks. In short, a farewell to ARMs is a hello to more money for the bank.

If you’re still waiting for the catch, here it is: loan modification affects your credit. (Not in a good way.) A lot of loan mod customers don’t realize that until it’s far, far too late. As a rule, avoid loan modifications unless you can live with a hit to your credit score. The question becomes: are lower or more consistent mortgage payments more important than good credit? If the answer is no, you may be better off looking at refinancing, or just staying in the mortgage you already have. If the answer is yes then you would be better off reading some of our other articles about short sales or foreclosure.

There are, of course, ways to solve the problem of loan mod credit pain. Be sure you discuss the terms of the loan modification with your bank before you sign. Banks can report the loan mod in several different ways to credit bureaus, which will have various effects on your credit. Have banks explain how they’re going to report the loan mod, and avoid “trial periods”. Part Two of this post will explain exactly what’s going on under the hood, and how you can get a loan modification that will not destroy your credit.

How did your loan modification affect your credit?