Will A Loan Modification Affect Your Credit?

Your Credit History and Loan Modification

One of the biggest concerns shared by many homeowners who have missed several mortgage payments is what options are available to them, and how each option can change their credit rating. While these borrowers know that their credit has deteriorated severely due to the foreclosure situation, they also want to maintain as much as possible their chances of borrowing money in the future.

Loan modification is the newest trendy method to stop foreclosure, with numerous government programs subsidizing banks and homeowners. Thousands of foreclosure consulting companies offering to help owners negotiate with the banks (for a fee) have also cropped up all across the country.

While changing the terms of a mortgage can be a great plan for some borrowers, few people have really questioned how a modification will be presented to the credit agencies. They are somewhat similar to refinancing a home, entering into a forbearance agreement with a lender, and even filing a Chapter 13 bankruptcy.

Government regulations, until very recently, have also been unclear as to how lenders should report a loan modification on clients' credit histories. Some lending institutions would have the record state "paid as agreed," while others would account for the payments as "partial payments." Some would even just keep the loan in a state of "foreclosure" until the temporary modification or repayment plan was completed.

All of these different ways had widely varying effects on a borrower's credit score. Having a loan shown as "paid as agreed" was obviously the best solution. Partial payments is considered a drawback to prospective lenders and would cause a decrease in the credit score. Having a credit report demonstrate a foreclosure would be almost as bad as just having filed bankruptcy and discharged all of the debt.

The new rule requires that banks report a mortgage modification to the credit rating agencies as "loan modified under a federal government plan." Another requirement is that this designation will have no effect on the borrower's credit (FICO) score. This is mostly due to the relatively small number of owners who have received a modification to avoid foreclosure.

Once there are more mortgages with the federal government designation, then the credit rating agencies will be able to decide how to change the debtors' scores. This will mandate more modifications to go through and past ones not to fall back to foreclosure status.

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