If you had a mortgage just a few years ago, fell on hard economic times or were offered a mortgage loan modification by your loan servicer and you're looking to apply for a new mortgage loan, you'll need to meet certain credit requirements to get a green light on a new loan. Here's what you need to know.
What Is a Loan Modification?
A loan modification, also known as a restructured mortgage, is a loan in which the original terms of the agreement have changed, resulting in the restructuring of the debt.
The most common forms of loan modifications had to do with rate and payment restructuring when borrowers were unable to refinance. Another common strategy for mortgage companies was to offer principal curtailment (reduce the amount owed) rather than forgive debt. The difference was repositioned as a lien on the home in the form of a silent second mortgage (a mortgage not disclosed to the original lender), which did not come into play until the home was refinanced or sold.
It is important to note here that a loan modification is different from a mortgage refinance. A loan restructuring changes the terms of the original mortgage, whereas a refinance pays off the original mortgage loan in exchange for another. Most homeowners these days are not seeking a loan modification, and most banks are not promoting them, as the economy has shifted tremendously from just a few years ago.
If a modified mortgage is in your past and you're looking to take out a new mortgage, then these rules apply:
- To be eligible, you have to have made at least 24 mortgage payments since the restructuring was completed. It is this black-and-white. Even if there was a second mortgage in place that was restructured, this same waiting time applies — whether the mortgage is on a primary home, a secondary home or an investment property.
- If you are purchasing or refinancing another property independent of the property that has a restructured loan, a one-year waiting time applies.
If your previous loan modification contained a forbearance, a period during which you did not make a mortgage payment and the additional interest was tacked onto the principal balance of the mortgage at the time the restructuring was completed or if there was a principal balance forgiveness, it's going to be up to the individual mortgage company to approve. Generally, mortgage loan companies frown on this, even if you have met the 24-month — or 12-month requirement — depending on your individual circumstances.
Planning Ahead: Refinance or Modification?
If your mortgage loan servicer offers you a lower monthly mortgage payment, make sure it is a bona fide refinance offer, rather than a potential loan modification. If you are unsure as to whether or not the offer you're receiving is a loan modification or refinance, be smart, get it in writing.
The best outcome to maintain your credit standing is refinancing rather than restructuring. If refinancing is not an option, perhaps due to home equity for example or a heavy debt load, and loan modifying is an option with your current loan servicer, know that you're going to be limited on your future mortgage options for up to two years.
Additionally, lenders are required to report modified/restructured mortgages on the tri-merge credit report mortgage banks use to make credit decisions. This financial services credit report is how banks find derogatory credit events. Even if you didn't have any missed mortgage payments, a restructured mortgage can still be a red flag to potential mortgage lenders.
If you had a home loan modification in the past few years and you want to buy a new home, it's a good idea to check your credit reports and credit scores to see how it may have affected your credit, and to see if there are any errors or problems you need to resolve before you apply. You can get your free credit reports from AnnualCreditReports.com and you can get your credit scores for free from several sources, including Credit.com.
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