Loan Modification Credit Woes

Loan modifications have become the preferred method of avoiding foreclosure over the last few years. Although many people are unsuccessful in obtaining them, and the government continues to create programs to entice lenders to grant more modifications, there is one aspect that is not often discussed in relation to those who obtain them: credit consequences.

Everyone knows that credit scores suffer after a foreclosure or short sale, but it comes as a surprise to many that the same occurs after a loan modification. After all, it is an agreement with the lender that keeps the borrower in her home and in good standing, with many of those borrowers never having missed a payment. Once the loan modification is complete it is not abnormal to have a 100 point drop in credit scores. Why?

The argument is that the homeowner is trying to do the right thing in modifying the loan, to avoid foreclosure or even a short sale. He or she has typically not missed any payments. So why be penalized? Everyone wins: the homeowner stays in the home and continues to make payments, albeit more affordable ones that reflect current market values. The lender avoids a short sale or foreclosure, losing thousands (or even hundreds of thousands) of dollars in fees and winding up with a vacant property to sell.

The credit rating industry justifies the hit by arguing that only those with financial difficulties seek loan modifications, thus other lenders and those who extend credit need to be aware of that fact.

This issue is just another thorn in the side of the embattled Making Home Affordable Program, which has only helped about 170,000 homeowners (although initially expected to help millions). For those lucky enough to be admitted to the program, there is a three month trial period under which the homeowner makes the new payments. If they are made on time and without any problems the applicant is granted the modification. The credit drop tends to occur during these three months, which could be a problem if the applicant does not qualify and then has to go through a short sale or foreclosure–at that point their credit score would have dropped immensely, with a potential double hit.

All in all this is just another hurdle for the troubled homeowner facing the possibility of not being able to make house payments. Although with a modification the credit score is not hit as hard as with a foreclosure it is still something to be aware of when deciding what to do.