How Does a Mortgage Loan Modification Work?

Who Qualifies for a Loan Modification?

You usually qualify for a loan modification if you have a real financial hardship, you live in the home, and your income can support the new payment. Each loan owner sets its own rules on top of that.

• Hardship: a lasting change in income or expenses, such as a job loss, pay cut, medical bills, divorce or a death in the family.
• Occupancy: most programs require the home to be your main residence.
• Delinquency: many programs start at 60 days late, but some allow imminent default, meaning you are current but about to fall behind.
• Income: you must be able to afford the modified payment, so you will need recent pay stubs, bank statements and tax returns.
• History: many programs limit how often you can be modified.

How Do Loan Modifications Differ by Loan Type?

Loan modifications differ by loan type because the loan’s owner or insurer writes the rules the servicer must follow.

• FHA loans: HUD’s Handbook 4000.1 sets a fixed-rate modification. The servicer first tries a 30-year modification that cuts the principal and interest payment by at least 25%, and if that is not enough, reviews a 40-year modification, often combined with a partial claim (HUD 4000.1 III.A.2). FHA borrowers can get a permanent option only once every 24 months. The details are in FHA loss mitigation options.
• Fannie Mae loans: the Fannie Mae Flex Modification requires the loan to be at least 60 days late or in imminent default, at least 12 months old, and modified fewer than 3 times before. The trial period is 3 months, or 4 if you are current or less than 31 days late.
• Freddie Mac loans: Freddie Mac’s guided steps to loss mitigation describe a Flex Modification that adds the missed amount to the balance, extends the term and may lower the rate, with a 3-month trial period.
• VA and USDA loans: both have their own modification rules, covered in VA loan help and USDA mortgage help.
• Bank-held loans: the lender decides, so ask for its written program terms.

The Fannie Mae and Freddie Mac programs are compared in more depth in Flex Modification.

How Do You Apply for a Loan Modification?

You apply for a loan modification by asking your servicer for a loss mitigation application, sending it back complete, and then making the trial payments on time.

1. Call and ask for the application. Ask your servicer for a loss mitigation application and the list of documents it needs.
2. Gather your documents. Most servicers want 2 recent pay stubs or profit and loss statements, 2 months of bank statements, the last 2 years of tax returns, a hardship letter and a signed tax transcript request.
3. Write a hardship letter. Explain what happened, when, and why your situation has changed. See the guide to a mortgage hardship letter.
4. Send a complete application. A complete application gets you the federal protections, including a decision within 30 days if it arrives more than 37 days before any sale (12 CFR 1024.41(c)).
5. Make every trial payment. Pay the new amount on time for the 3 or 4 month trial. A missed trial payment usually ends the offer.
6. Sign the permanent agreement. Read the new rate, term, balance and any deferred amount before you sign, and keep a copy.

The deadlines that protect you during this process are set out in the CFPB’s loss mitigation rule and explained step by step in loss mitigation deadlines.

What Should You Check Before You Accept?

Before you accept a modification, check that the new payment fits your budget with room to spare, and that you understand how the loan will look over its full life.

• Monthly payment: include taxes and insurance, not just principal and interest.
• Interest rate and term: a 40-year term lowers the payment but raises the total interest you pay.
• New balance: the missed payments, interest and some fees may have been added.
• Deferred balance: any amount set aside is due when you sell, refinance or reach the end of the loan.
• Rate changes: a fixed rate is safer than a step rate that rises later.