Loan modifications change the terms of your loan with the goal of making the payment more manageable. Unlike refinancing a loan, having a loan modified means the loan remains with the same lender — just under revised terms.
Loan modifications can be challenging to obtain and typically decrease your credit score. But for some borrowers, they may be the only option, if the lender agrees to the terms.
So what is a loan modification and how does it work? Let’s explore the details below.
Loan Modification Defined
A loan modification is a revision to the terms and conditions of an existing loan. The lender and borrower agree to new terms that make the monthly payments more manageable for the borrower and prevent the lender from having to take more expensive, drastic actions, like foreclosing on a property.
While loan modifications are most common for secured loans, like home mortgages, it’s also possible to get student loan modifications and even personal loan modifications.
How Do Loan Modifications Work?
The goal of a loan modification is to make a borrower’s monthly payments more manageable. Typically, borrowers will consider this option if they’re at risk of defaulting on their loan (or if they already have). In the case of mortgages, loan modifications can help prevent foreclosure.
Borrowers may also look for loan modifications in times of hardship, like a serious illness or injury. In this case, borrowers might also request a loan deferment.
So how do loan modifications work? They’re a two-way street: The lender and the borrower must come together and agree to a change of the loan terms. The approach can vary, but strategies may include:
• Adjusting the interest rate: If interest rates were high when you first took out your loan, your lender may agree to lowering the interest rate on your loan. Doing so typically reduces your monthly payment. SoFi’s personal loan calculator is one tool that might be helpful in determining how a new interest rate can affect your monthly payments.
• Extending the length of the loan: Extending the loan could reduce your monthly payment, though adding more years to a loan may mean you’ll spend more on interest in the long run. Still the immediate relief it offers might be worth it.
• Changing the structure of the loan: If your loan has an adjustable interest rate structure, you might benefit from modifying it to a fixed rate. This can make your monthly payments more predictable.
• Reducing the principal balance: In some cases, a lender may agree to temporarily reduce the amount owed on your principal to make it easier to manage your monthly payments. Note, however, that you’ll have to make up for those reduced payments later. In the case of mortgages, this is a rare strategy that is typically only considered to avoid foreclosure. Student loan forbearance is also possible.
When Should You Use Loan Modification?
Loan modifications are often a last resort. Here are some scenarios when it might be time to consider loan modification:
• Risk of foreclosure: If you’ve missed multiple payments on your mortgage or cannot afford to make future payments at the current amount, a lender may be open to modifying. This can prevent you from losing your home to foreclosure and may save the lender money in the long term.
• Underwater on a mortgage: An underwater mortgage (also called an upside-down mortgage) occurs when you owe more on your home than it’s worth. This can happen if your home’s property value plummets or if you miss payments early on and are playing catchup on accumulated interest. Loan modification may be the right solution for you and your lender.
• Defaulting on a personal loan: If you cannot afford your upcoming monthly personal loan payment or have already missed one or more payments, it may be worth seeing if you can have your loan modified, likely by extending the life of the loan to reduce your monthly payments. This may be more agreeable to a lender than having to take expensive legal action against you.
• Financial hardship: If you are undergoing some kind of hardship, such as a debilitating medical condition or loss of job, you may want to work with your lender to see if you can modify your loan before you miss a payment.
Does Loan Modification Hurt Your Credit Score?
A loan modification will show up as a negative entry on your credit report and thus could drive down your credit score.
That said, if you’re missing payments on your loan because you can’t afford them — or worse, verging on home foreclosure in the case of a mortgage loan — that can have an even more dramatic impact on your credit.
Recommended: What Credit Score Is Needed For a Personal Loan?
How Often Do Loan Modifications Get Approved?
While getting a personal loan can be a simple process, approval for loan modifications vary by lender, loan type, and the borrower, but they’re typically more challenging to get than refinancing. Lenders are not obligated to approve your loan modification, but it may be in their best interest to avoid an expensive foreclosure process.
You might be able to improve your chances of approval by working with a debt settlement company. These companies advocate on your behalf with the lender and have more time and experience to negotiate.
However, debt settlement companies aren’t free, and there’s no guarantee that they’ll be successful in getting your loan modified.
What Does It Mean to Refinance Your Personal Loan?
Personal loan modification is possible, but for many borrowers, it may make more sense to refinance a personal loan. You might consider refinancing a personal loan to achieve one of several goals. Here’s a look at a few of them:
Shortening Your Term
If you initially took out a personal loan with a particularly long term, you could try to refinance for a shorter term and pay it off sooner. While your monthly payment would go up, you might pay less in interest over the life of the loan.
Lowering Your Monthly Payment
On the flip side, you could extend the length of your loan when refinancing to lower your monthly payment. While you might pay more in the long term, this strategy could be helpful if you’re struggling to pay your bills each month.
Lower the Interest Rate
If you took out a personal loan when interest rates were higher — either because of your credit score or the state of the market — it could be worth refinancing to get a better personal loan rate. Depending on the difference in the interest rate and the size and length of the loan, refinancing could save you a considerable amount of money.
Recommended: Loan Modification vs. Refinancing
How to Get a Loan Modified
Lenders are under no obligation to modify your loan, but it’s worth a shot if you don’t see any other options.
Qualifying for modification usually requires missed payments and a demonstration of personal hardship. In some cases, borrowers may qualify for a government loan modification program.
Thinking about applying for loan modification from your lender? You’ll need to assemble a wide range of documents for your application, including:
Proof of Income
Or rather, proof of lack of income. Demonstrating to the lender that you do not currently earn enough income to afford your loan payment is crucial to making your case.
Self-employed individuals may need to supply a profit and loss balance, while salaried and hourly workers can supply an employment contract demonstrating their pay.
Your most recent tax return can also offer insight into your income and overall financial standing.
Bank Statements
Lenders typically want to see your bank statements as well. This will verify how much money you have but will also show them your spending habits.
Hardship Statement
A hardship statement is your chance to make your case. You can use this formal letter to explain your hardship — medical issues, divorce, unemployment, etc. — and how it has affected your finances.
You may be more successful if you include documentation to support your argument. This might include medical bills, divorce paperwork, or a termination letter.
The Takeaway
A loan modification can help make monthly payments more manageable for borrowers and can be a useful strategy for those who are at risk of defaulting on their personal loan or having their house foreclosed. The lender and the borrower must agree to a change of the loan terms. Strategies may include adjusting the interest rate, extending the length of the loan, changing the structure of the loan, and reducing the principal balance.
Are you looking for a personal loan with no hidden fees at competitive interest rates that makes it much easier to manage your monthly payments? Consider a personal loan from SoFi. Check your personal loan rate with SoFi in as little as 60 seconds.
FAQ
Does a loan modification hurt your credit?
A loan modification results in a negative mark on your credit report, which can lower your credit score.
However, the alternative for many borrowers is missed payments and, in the case of a mortgage or car loan, eventual foreclosure or vehicle repossession. These can have an even worse impact on your credit score.
What qualifies as a loan modification?
Loan modification is a revision to the terms of an existing loan. The borrower and the lender must both agree to those terms. Modifications can take many forms, but often the lender will reduce the borrower’s interest rate, increase the length of the loan, or change the rate structure from adjustable to fixed.
What are the types of loan modifications?
Borrowers can seek out loan modifications for various types of loans, but mortgage modifications are the most common. Borrowers with unsecured loans, like personal loans and student loans, may also be able to get modifications. Modification types include changes to the interest rate, rate structure, and length of the loan. In some cases, lenders may temporarily adjust the principal balance as a type of loan modification.
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