How Do Loan Modifications Work?

Since the housing downturn started in 2006, some mortgage loans are more than the value of the houses. Compounding the issue is the problem of unemployment, which may make a homeowner's mortgage payments unaffordable. The Obama administration's loan modification effort aims to deal with these issues and also provide support to the housing market.

Definition

• A loan modification is a change made to the mortgage's loan terms. The government's mortgage loan modification program aims to help homeowners stay current with their mortgage payments by making their payments affordable.

Modification

• One way of modifying a loan is to reduce the interest rate the mortgage note carries. For instance, the modification could result in a six percent interest rate being reduced to a three percent rate. Another way is to extend a 30-year mortgage loan to a 40-year loan, so that monthly payments are lower. The bank could also forbear the principal for a certain period.

Lender Analysis

• The lender will conduct an analysis of the cash flow it will get from the loan if it is modified and if it is not modified. If the lender's analysis reveals a more positive outcome for the lender if the loan is modified, then the loan is eligible for modification. The lender could also make a decision based on the individual's specific circumstances. For instance, if a mortgagor is unemployed, but her spouse who is not a co-borrower on the mortgage is employed, the bank may be able to use the spouse's income to qualify the modification.