Mortgage Loan Modification: Lowering Your Payments

Unlike repayment plans and forbearance, mortgage modifications are designed to lower your monthly payments over the long term. You might be able to get a modification from your servicer, but don’t be surprised if your attempt doesn’t yield much.

For information on other workout options available through your mortgage servicer, see our article Basic Mortgage Loan Workout Options. For information on modifying your mortgage through HAMP, see our article What is the Home Affordable Modification Program (HAMP)?

Is Modification Right for You?

Mortgage modifications are designed to help homeowners who can’t come close to making their current mortgage payments now or in the future. There are many reasons borrowers are unable to pay their mortgages, including:

• Their income stream was disrupted by a layoff or injury, and a new job at the same pay is just not available.
• They were in over their heads from the beginning, because of predatory loan practices or their own misstatements about their income and debt load.
• Their interest-only loans caused the principal to reach a preset cap, which in turn dramatically pushed their monthly payment upwards to an unaffordable level.
• Their interest rates reset higher (currently not as big a problem as was originally feared, due to continued low short-term interest rates engineered by the Federal Reserve).
• Something happened in their life that required them to reprioritize their budget—for instance, a medical emergency or a child in trouble.

If you can’t afford your mortgage payment now or won’t be able to in the near future, mortgage modification is the best approach to remaining in your house.

How Will Modification Help?

Here are some of the ways your servicer might modify a mortgage to reduce your payments and perhaps also the outstanding balance of your loan to the value of your home:

• Reduce your mortgage’s interest rate to the current market rate, if the current market rate is lower than what you’re supposed to be paying now.
• Convert from a variable-rate to a fixed-rate mortgage, which will bring the payment down if the interest on the variable-rate mortgage has already reset, and will prevent a jump in payments if the reset looms in the near future.
• Extend the loan’s repayment period—for instance, from 30 to 40 years. This will bring down the monthly payment but delay for many years the time when you can begin to build equity.
• Reamortize the loan. This involves adding the amount of the missed payments to the principal balance and issuing a new loan at a new interest rate for a new period of time. Reamortization can result in an increased payment (for example, if the interest rate stays the same or increases) or a reduced one (if the interest rate is reduced and the loan period is increased).

Be Aware of Deferred Junior Mortgages

If your servicer agrees to a reduction of your mortgage principal and then the value of the house goes back up, the lender will want to be able to get some of its original principal back. To do this, the mortgage industry has come up with a device for recapturing some mortgage principal, called “deferred junior mortgages.” These devices commit you to pay them off when you sell or refinance the house. They can’t, however, be enforced by foreclosure or a lawsuit.

Example: Aura was recently laid off from a job paying $36 an hour and has found a new job paying $28 an hour. In the meantime, the house she bought for $240,000 two years ago has fallen in value to $180,000. To keep her house, Aura will need a substantial reduction in her payments. Because she has a good payment history and a decent credit score, the lender agrees to reduce the principal due on her mortgage to the house’s market value ($180,000), which results in the reduced payments Aura needs to stay in the house.

In exchange, Aura agrees to a deferred junior mortgage for $60,000 at 6% interest. Under the terms of this deferred junior mortgage, Aura will not face foreclosure or a lawsuit for failure to pay off the mortgage, but will have to pay it off if she refinances the principal mortgage or sells the house.

Three years later, Aura would like to sell the house. However, a sale will not generate enough cash to cover both the principal mortgage and the deferred junior mortgage, so Aura is stuck with the house until times get better or she gets rid of the deferred junior mortgage by filing for Chapter 7 bankruptcy.

Excerpted from The Foreclosure Survival Guide, by Stephen Elias (Nolo).