How Does Mortgage Loan Modification Work?

If you’re having trouble keeping up with your mortgage payments and need more than a temporary solution, a loan modification can adjust the original terms of your mortgage to help you avoid foreclosure.

The Flex Modification program for borrowers with a conventional loan owned by Fannie Mae or Freddie Mac is a popular option — but before you permanently alter your mortgage, make sure you understand when it makes sense to get a loan modification. We’ll cover the pros and cons of mortgage modifications and highlight other options for managing mortgage payments when you’re struggling financially.

What is a mortgage loan modification program?

A mortgage modification changes the original terms of your home loan to make your payments more manageable. Your lender can modify your loan in a few different ways, including:

Remember: The ultimate purpose of participating in a mortgage modification program is to make changes to your mortgage that’ll help you avoid missed payments and foreclosure.

Modifications can be especially helpful for homeowners who are experiencing a hardship that doesn’t have a clear end in sight. If, on the other hand, you’re recovering from a temporary problem — say you have a short-term illness or injury, or you’ve lost your job — you may want to look at less-permanent options like mortgage forbearance or refinancing.

Loan modification after forbearance

If you’re already participating in a mortgage forbearance program and it looks like you can’t afford any of the options that would bring your loan current after forbearance ends, a loan modification may be just what you need.

How loan modification works

The loan modification process can vary from lender to lender, but in general most programs will require similar steps:

Step 1 Gather information about your financial situation. Having documentation about your income, PITI payment amounts, HOA payment amounts and property value at the ready will make the process a lot less frustrating.

Step 2 Reach out to your lender. Because your mortgage loan is a legal agreement between you and your lender, you can’t modify your home loan without the lender’s approval.

Step 3 Check the qualifications for loan modification. Different lenders and programs will have different requirements you’ll need to meet in order to modify your loan. Before you launch into the loan modification application process, review your program’s basic qualifications.

Step 4 Complete an application. You’ll need to submit information and documentation about your financial situation to your lender in order to help them understand why you’re experiencing hardship. Depending on the program, you may need to submit a “hardship letter” that details your situation in narrative form.

Step 5 Complete trial payments. In some cases, you may need to make a series of “trial payments,” which show the lender you’re able to make on-time payments consistently. If you fail to make these payments, you could lose your chance to modify your loan. The trial period typically lasts three to four months.

Step 6 Await the final verdict. Your lender will either approve or deny your application. If you’re approved, you’ll get an offer that details the terms of the new loan. If you’re denied, know that there are other options that can help you either afford or exit your mortgage without going through foreclosure.

Qualifying for the Flex Modification program (FMP)

One of the more common home loan modification options is the Flex Modification program offered by government-sponsored enterprises Fannie Mae and Freddie Mac. The program can provide a 20% reduction in how much you have to pay monthly toward your mortgage — but it’s only available to struggling borrowers who have conventional loans that are owned by one of these two agencies.

The Fannie Mae and Freddie Mac Flex Modification programs have many requirements that apply to borrowers in different circumstances, but in general the Flex Modification Programs require that you:

• Be in imminent default. This means you’re expected to fall behind on your mortgage payments in the next 90 days, or already at least 60 days delinquent.

→  For borrowers in imminent default, the loan must be attached to their primary residence.

• Have a mortgage that’s at least one year old. Your mortgage origination date must be at least 12 months prior to the modification evaluation date.
• Haven’t already modified the loan too many times. Your mortgage must not have been modified three or more times in the past.
• Have kept up with your trial payments. You may not have failed a “Flex Modification Trial Period Plan” over the last 12 months.
• Submit a borrower response package (BRP). This is essentially the application for a modification, and will ask you to provide information and documentation about your finances, your hardship and your home. Fannie Mae requires a BPR if you’re less than 90 days behind on your payments, while Freddie Mac requires it for all borrowers (more on this below).

Each lender will have different requirements before they’ll consider a mortgage modification. If you’re pursuing a modification directly with your lender, they may have different or additional requirements. Be sure to verify their guidelines by reaching out for more information.

Unsure if Fannie or Freddie owns your loan?

You can use Fannie Mae’s loan lookup tool or Freddie Mac’s tool to find out which agency owns your loan. If one of them does own your loan, you may be eligible for the Flex Modification program — provided you meet its other requirements.

Pros and cons of loan modification programs

Other mortgage modification programs

Both the Federal Housing Administration (FHA) and U.S. Department of Veterans Affairs (VA) have mortgage modification programs for eligible borrowers.

FHA loan modification

The FHA loan modification program helps struggling homeowners by using one of the following options:

• Adding late payments to their principal balance.
• Extending their loan term.
• Lowering their interest rate.
• Reducing their outstanding balance by up to 30%.

Eligible borrowers must:

• Not qualify for other mortgage assistance programs.
• Have a debt-to-income (DTI) ratio of no more than 31% on the front end and 55% on the back end.
• Complete a three- to four-month trial, which depends on whether they’re in default or imminent default.

Good news for FHA loan borrowers: COVID-19 protections extended

The FHA has extended all of its COVID-19 loss mitigation options to all borrowers with FHA loans — regardless of the reason for their financial hardship — and will keep these options in place until Oct. 30, 2024. These include loan modifications but also partial claim loans, regular and unemployment-specific forbearance options, as well as combinations of these strategies.

In addition, for borrowers who are still struggling financially for reasons related to the pandemic, the FHA will continue to offer COVID-19-specific forbearance — just be sure to request it by May 31, 2023, the official date the COVID-19 national emergency will end.

VA loan modification

VA loan borrowers who qualify for a modification may receive help by:

• Having their past-due amount added to their outstanding principal balance and calculating a new repayment schedule.
• Extending their loan term and getting a lower monthly payment.

Eligible borrowers must:

• Have made at least 12 monthly payments since their mortgage closing.
• Demonstrate their ability to repay the mortgage and not default.
• Not have had any loan modifications over the past three years.
• Not have had more than three loan modifications since their mortgage closing.

Loan modification vs. refinance

If you don’t qualify for loan modification, don’t panic — you can still potentially get a refinance. Like modifying your mortgage, a refinance permanently changes your loan. However, instead of modifying the existing loan, it uses a new loan to pay off your original mortgage. You’ll then continue to make payments based on your new loan’s terms.

When a loan modification makes more sense:

• You’re already behind on your mortgage payments. It’s going to be tough to refinance if you’ve already fallen behind on one or several mortgage payments — most lenders don’t want to issue a new loan to someone who has a recent history of missing payments.
• You’re “underwater” on your existing mortgage. If you owe more than your home is worth, you typically won’t be able to refinance a conventional loan. However, if you’re underwater on a government-backed loan, you may be able to qualify for a streamline refinance loan.
• You’re hoping to have part of the loan’s principal balance forgiven. In some cases, a loan modification increases your principal balance, but in others it forgives some of that balance. Refinances, on the other hand, can increase your balance, but can’t reduce it.

When a refinance makes more sense:

• You’re not behind on your payments yet, but if something doesn’t change you will be soon. If you’re still holding onto your solid credit and a pattern of on-time payments, now — before you fall behind — is the time to seek a refinance.
• Interest rates are significantly lower than when you took out your loan. A good rule of thumb is that a refinance may be a good option if it can reduce your interest rate by at least 1 percentage point. Unfortunately, with today’s rates and mortgage forecast looking the way they do, you’re unlikely to find lower rates now unless you’ve significantly improved your credit.
• You’ve taken closing costs into account. A refinance will typically come with closing costs of around 2% to 6% of the loan amount. This is fine, as long as you can afford these costs and plan to stay in your home long enough to break even on the refinance.

Loan modification vs. forbearance

Forbearance is a temporary pause or reduction in your mortgage payments, whereas loan modification permanently alters your loan. You can also enter loan modification after a forbearance period — the two aren’t mutually exclusive, but they are different.

One notable difference about forbearance is that, because it doesn’t alter the original loan agreement, you’re technically in mortgage default during the forbearance period. For the most part, this is a technicality that doesn’t matter as long as your lender is on board with forbearance and you’re keeping up your end of the deal during that period.

However, if you fail to do what you agreed to in the forbearance agreement, things can get messier. In some cases, when borrowers violate the forbearance agreement, the lender turns around and takes legal action against them — and uses the forbearance agreement as evidence in court to prove their case.

Alternatives to loan modification, forbearance and refinancing

Even if loan modification, forbearance and refinancing all fail you, you still don’t necessarily have to go into foreclosure. Here are some alternatives:

• Short sale A short sale is when your lender agrees to let you sell your home for less than it’s worth. In return, the proceeds of your home sale will go toward your outstanding mortgage debt. The debt that remains after this — called the “deficiency” — is often forgiven.
• Deed-in-lieu A deed-in-lieu of foreclosure is when you hand over ownership of your house to your lender “in lieu” (or instead) of going through the foreclosure process. In return, you’ll be released from the mortgage. Lenders are often motivated enough to avoid foreclosure that they’ll strike this deal with you — and, in some cases, cover your relocation expenses to boot.
• Partial claim A partial claim is a loan that covers the amount you’re behind on your mortgage payments by. The best part is that it’s interest-free, and typically won’t have to be repaid until you pay off your first mortgage in full or sell the house. The downside? It only applies to certain loan types, like FHA loans.
• Bankruptcy Deciding to file for bankruptcy can be tough, but one of the best things about taking the leap is that it immediately puts a freeze — also known as an “automatic stay” — on any creditors who are trying to collect from you. This will stop foreclosure, but whether this is enough to help you keep your home, or if it’s just a temporary fix, depends on the type of bankruptcy you’ve filed for.

How to avoid loan modification scams

Remember: It’s against the law for a business that promises it’ll help you obtain a loan modification to collect any upfront fees from you before you’ve signed a new loan agreement with your lender. Do your due diligence when seeking mortgage assistance and verify that you’re receiving legitimate loan modification help. File a complaint with the Consumer Financial Protection Bureau (CFPB) online or by phone at 855-411-2372 if you believe you might be the victim of a mortgage modification scam.