Sometimes, life gives you lemons, and it may affect your ability to pay your mortgage in full and in time. It won’t be long before your lender starts calling you, again and again, to remind you of your obligations.
When you are in such a stressful situation, it might be tempting to ignore those phone calls. However, your lender may be able to modify the terms of your loan so you can make your payments more easily and avoid foreclosure. This is a different situation than refinancing a loan, which consists of contracting a new loan entirely to pay off the previous one.
Your current lender may propose several options:
- A forbearance agreement consists in allowing you to suspend or reduce your payments for a limited time, from a few months to a year. It is not a permanent solution, but it can provide short-term relief for borrowers who may be able to pay later (if they are on disability leave, or have a job lined up after being laid off but may not be paid for several weeks for example). However, the debt does not disappear: the borrower will still have to pay the full amount after the forbearance agreement ends, and he or she will also have to pay the amount necessary to get current on the missed payments, including principal, interest, taxes, and insurance. The difference will either be paid by adding to your monthly payment, or by adding some payments at the end of your loan.
- A loan modification changes the terms of the loan permanently. The conditions vary widely depending on the situation, but the changes may affect several elements that can contribute to reducing your monthly payments.
- Modification of the interest rate: the lender might be willing to reduce your interest rate, or switch from an adjustable rate mortgage to a fixed rate mortgage.
- Modification of the term of the loan (also known as re-amortization): by extending the life of the loan, the lender will help lower what you owe every month. However, you will end up paying more in the long run as the interests add up. You will also have less equity in your home.
- In very rare cases, your lender might be willing to reduce the principal of your loan. It is the most favorable option for the borrower, but keep in mind that according to the Mortgage Forgiveness Debt Relief Act of 2007, you will have to declare the forgiven debt on your federal tax return.
How to ask your current lender to modify your loan?
Although having a reduced monthly payment on your mortgage can be a huge relief for those in a difficult spot, you will need specific circumstances to convince your lender to modify the terms of your mortgage. Tempting as it might be, it is not always a good idea either. It is likely that your credit score will be negatively impacted, but not as severely as for a foreclosure.
If you are struggling to meet your monthly payments, it is a good idea to contact your lender to see what options they may offer. Some institutions require the borrower to be delinquent for at least 60 days or about to become delinquent before agreeing to a loan modification.
You will also need to prove that you are encountering some difficult circumstances that affect your ability to make your payments on time and in full. Qualifying hardships may be:
- Loss of a job
- Loss of a spouse, particularly the primary breadwinner
- Divorce (in some cases)
Depending on the lender, you will need to provide a hardship letter explaining your circumstances or proof or hardship. You will also need to provide your bank with a list of your incomes and expenses and any document (pay stubs, bank statements, tax returns, loan statements, etc.) related to your financial situation.
Although a loan modification can be a lengthy and gruesome process, it can also help many homeowners avoid foreclosure.