Mary Johnston: How Much Will A Loan Modification Reduce My Payment?

Struggling homeowners are often under the misconception that a loan modification will lower payments. Missed payments, taxes, insurance, interest and late fees must be repaid. When you apply for a modification, the lender rolls all the money owed into the loan balance. A loan modification lowers the interest rate and may extend the length of the loan, but this may not reduce the mortgage payment. Contact your mortgage company before you fall too far behind. Typically, loan modifications result in a payment increase when a borrower is very delinquent.

Most lenders require you to miss at least two payments before considering a loan modification. If you haven’t yet missed any payments, consider refinancing or requesting forbearance. In forbearance, the lender agrees to temporarily postpone payments until you can get back on your feet. Certain banks offer borrowers a principal reduction to lower the total amount owed on the loan. In 2012, The U.S. Department of Justice and the state attorneys general agreed to the terms of a global settlement with mortgage lenders to offer qualified borrowers principal reductions. To qualify, you must be at least 60 days delinquent and your home must be worth less than you owe. The maximum forgiveness amount is 30 percent of the remaining principal balance. Although the most well-known modification is the Home Affordable Modification Program, lenders also offer private modifications. The lender will determine your eligibility and send you the proper paperwork. A loan modification application generally requires you to list all debt, expenses and sources of income.

The lender will pull a copy of your credit report just in case there is some debt you may have missed. Even if an old account is in collection, it counts towards your debt-to-income ratio. You may need to submit recent pay stubs, W-2 forms and income tax returns. For HAMP, applicants must complete a hardship affidavit. Possible hardships can include a loss in income or an increase in monthly expenses. Your lender may want a hardship letter explaining the circumstances, such as a medical condition or injury. Submit the paperwork and documents promptly. You want to act fast to avoid falling even further behind on the loan. Any errors can delay the process. Pay your mortgage on time after gaining approval. According to Realty Times, the loan modification process typically takes up to 90 days. Approval times can vary depending on the lender and whether or not further documentation is required. If your mortgage payment is lowered through the modification, you will need to prove you can afford the new payment. A three-month trial period is a standard part of HAMP. During the trial period, the foreclosure clock continues to click. During this stage, you aren’t in the clear. Even if a payment is lost in the mail, the lender can proceed with the foreclosure. HAMP rules give borrowers 30 days to respond and appeal to a non-approval notice before moving abead with the foreclosure.

Homeowners with modified mortgages that have step rate features will experience changes in their interest rate and monthly payment after a certain period of time, typically five years. The step rate feature will gradually increase the interest rate (usually no more than 1 percentage point per year), which will also change the monthly payment amount. Prepare yourself by reviewing documentation from your mortgage company to understand the specific details of your loan modification. Pay close attention to any changes noted for your interest rate, the payment amount, and the date the changes will take effect. If you use an electronic payment method to pay your mortgage, be sure to update it to the new payment amount before the due date. If you’re concerned—or anticipate challenges—with a new monthly payment, your mortgage company can review your options with you. The options include continuing to pay according to the terms of your loan modification agreement, or perhaps refinancing to lock-in an interest rate.

The sooner you take action, the more options you may have. Get started by contacting:

• Your mortgage company to review the changes to your modification and discuss payment options;
• The Homeowners HOPE Hotline (1-888-995-HOPE) to speak with a housing expert about your situation and an action plan;
• A HUD-approved housing counseling agency (www.HUD.gov) for financial and budgeting assistance, and to find an approved housing counselor; or

If your mortgage was modified with a step rate feature your interest rate was reduced below the prevailing market rate at the time your loan was modified. After a certain period of time (usually 5 years), your interest rate will begin to adjust, or step up, based on the terms of your modification agreement. It will continue to adjust (usually no more than 1 percentage point) each year until it reaches the interest rate cap. The cap is not your original mortgage interest rate, but the market rate at the time you received your modification. With a step rate, your interest rate will increase each year (which will change your monthly payment) until your modified loan reaches its interest rate cap. After that, your rate will be fixed for the remaining life of the loan.

Let’s use a simple example to illustrate how this works on a loan modification scheduled to reset this year. Assume the loan was modified five years ago and the rate was fixed during that five-year period. This is an example only—your loan terms will be different.
Example:

• The current modification interest rate is 3%.
• The interest rate cap is 5.125% (as defined above).
• The loan—according to the modification agreement—adjusts by a maximum of 1 percentage point every year until it reaches the interest rate cap. Therefore, the interest rate on the loan will:
• Adjust 1 percentage point this year to 4%.
• Adjust 1 percentage point next year to 5%.
• Adjust 0.125% percentage point the following year to 5.125%.
• Remain fixed at 5.125% for the remaining term of the loan (since 5.125% is the interest rate cap, this would be the final interest rate adjustment).

Several months before an adjustment happens, your mortgage company will send you a letter(s) with specific details about the step rate adjustment, your new interest rate, and new payment amount. If your loan was modified about five years ago, contact them immediately if you have not received a letter and/or would like to discuss your payment information with them. Once you receive a letter or talk with your Mortgage Company about the upcoming changes, pay close attention to the date your new payment amount is due. Be sure to pay the new amount by the due date to keep your loan from being past due and from being charged a late fee. If you use an electronic payment method to pay your mortgage, make sure to update it to the new amount before the due date. A loan modification is a permanent restructuring of the mortgage where one or more of the terms of a borrower’s loan are changed to provide a more affordable payment. With a loan modification, the loan owner (“lender”) might agree to do one of more of the following to reduce your monthly payment:

• reduce the interest rate
• convert from a variable interest rate to a fixed interest rate, or
• extend of the length of the term of the loan.
Generally, to be eligible for a loan modification, you must:
• show that you can’t make your current mortgage payment due to a financial hardship
• complete a trial period to demonstrate you can afford the new monthly amount, and
• provide all required documentation to the lender for evaluation.
Required documentation will likely include:
• a financial statement
• proof of income
• most recent tax returns
• bank statements, and
• a hardship statement.

If you’re currently unable to afford your mortgage payment, and won’t be able to in the near future, a loan modification might be the ideal option to help you avoid foreclosure.

Forbearance Agreements

While a loan modification agreement is a permanent solution to unaffordable monthly payments, a forbearance agreement provides short-term relief for borrowers. With a forbearance agreement, the lender agrees to reduce or suspend mortgage payments for a certain period of time and not to initiate a foreclosure during the forbearance period. In exchange, the borrower must resume the full payment at the end of the forbearance period, plus pay an additional amount to get current on the missed payments, including principal, interest, taxes, and insurance. The specific terms of a forbearance agreement will vary from lender to lender. If a temporary hardship causes you to fall behind in your mortgage payments, a forbearance agreement might allow you to avoid foreclosure until your situation gets better. In some cases, the lender might be able to extend the forbearance period if your hardship is not resolved by the end of the forbearance period to accommodate your situation. In forbearance agreement, unlike a repayment plan, the lender agrees in advance for you to miss or reduce your payments for a set period of time.

Repayment Plans

If you’ve missed some of your mortgage payments due to a temporary hardship, a repayment plan may provide a way to catch up once your finances are back in order. A repayment plan is an agreement to spread the past due amount over a specific period of time.

Here’s how a repayment plan works:
• The lender spreads your overdue amount over a certain number of months.
• During the repayment period, a portion of the overdue amount is added to each of your regular mortgage payments.

• At the end of the repayment period, you’ll be current on your mortgage payments and resume paying your normal monthly payment amount.
This option lets you pay off the delinquency over a period of time. The length of a repayment plan will vary depending on the amount past due and on how much you can afford to pay each month, among other things. A three- to six-month repayment period is typical.

Extended Payment Terms

One way to reduce the monthly payment on a mortgage without changing either the interest rate or the principal is to extend the term of the loan. For example, if a borrower has a $150,000 mortgage that they took out at an interest rate of 6 percent for 30 years, the payment on the principal and interest would be $899.33. If the terms of the loan were extended from 30 to 40 years, the payment would become $825.32, for a savings of $74.01 per month, or just under $900 per year. The savings each month are definitely a benefit, but the homeowners will now be making payments 10 years longer before their home is paid off. This may be a viable option though, given the alternative of foreclosure, especially if the borrower intends to move at some point in the future.

Interest Rate Reduction

Lenders will sometimes agree to reduce the interest rate on a mortgage, usually as a temporary measure. Reducing the interest rate on a mortgage for even a short period of time can help a homeowner through a financial crisis. A permanent interest rate reduction is more commonly achieved by refinancing the loan. Continuing the example from above, if a homeowner with a $150,000 mortgage for 30 years at 6 percent was to get a temporary rate reduction to 4.5 percent; the monthly payment would drop from $899.33 to $760.03. This is a savings of $139.30 per month. The interest that the lender forgoes during the period when the rate is reduced may be forgiven, but more typically is added to the back end of the mortgage, to be repaid when the loan matures or the property is sold.

A Principal Forbearance is where the lender forgives the interest on part of the principal. They in effect collect zero percent interest on part of the loan. The borrower still owes the entire principal to the lender, but will pay it back when the property is either sold or refinanced, or when the loan matures. A Principal Reduction is just as it sounds. The lender reduces the amount of principal that the borrower owes, with no expectation of repayment. Debt Forgiveness is analogous to a principal reduction. This is a more effective way to reduce payments than either lowering the interest rate on the mortgage, or extending the terms. Again in the example from above, if the same homeowner with a 6 percent, $150,000 mortgage for 30 years were to get a principal reduction to $125,000, the payment would go from $899.33 to $749.44, for a savings of $149.89 per month.