If you’re in the process of getting or have already finished up the loan modification process, it may be challenging to find a lender willing to provide you with a home equity loan. Your credit history could be damaged from the events leading up to the modification, and perhaps even the modification itself.
Learn more about how loan modification impacts your chances at a home equity loan, your options for finding out more about your situation, and alternatives to home equity loans.
Key Takeaways
- Getting a home equity loan depends on your credit score, the lender’s requirements, and other factors.
- A loan modification changes the original terms of your mortgage, often due to a long-term or permanent hardship.
- Events leading up to a modification and the modification itself can impact your credit score.
- Lenders report modification details in different ways, some of which may lower your credit score.
What Is Loan Modification?
A loan modification is an agreement between you and your mortgage company to change some aspect of your original loan. Usually, the loan modification aims to reduce your monthly payments. For example, you might agree to change how much you pay, how long you’ll pay the mortgage, or reduce the interest rate.
Loan modification is meant to help qualifying borrowers with long-term money problems, past-due monthly mortgage payments, or an inability to refinance. The loan modification also helps resolve past-due payments, so you’re no longer delinquent with your mortgage company.
Lenders may offer modifications for first mortgages and home equity loans or home equity lines of credit (HELOCs). For example, a loan modification could change your mortgage in the following ways:
- Extend the repayment period from 30 years to 40 years
- Reduce the interest rate
- Change the loan type (such as from adjustable rate to fixed)
A loan modification differs from a loan forbearance because the mortgage changes are permanent. With forbearance, the mortgage lender or servicer provides a temporary pause or lower payment—which you’ll have to pay back later.
Note
With a loan modification, the borrower will often need to complete a three- to four-month trial period with the new, modified terms; if you make all payments as promised, the permanent changes could take effect.
How Does Loan Modification Affect Your Credit?
Most homeowners who need a loan modification are usually in a "drastic situation," said Charlestien Harris, a Credit/HUD Certified Housing Counselor at Southern Bancorp Community Partners in Clarksdale, Mississippi. "Maybe the husband dies and the wife can no longer afford a payment because she was dependent on his income, or the homeowner has a catastrophic illness. You have to write a hardship letter that explains the hardship, how long the hardship will last, or if it's permanent—and that's why you can’t make your original terms."
Your credit score after a modification could improve, decline, or stay the same based on your personal credit history and the terms of your new agreement. For example, if the lender folds your past-due amounts into your unpaid mortgage balance, you may have a higher debt-to-income ratio, bringing down your credit score.
When servicers report the modification, they'll use a special comment code to indicate the loan was modified from its original terms. This code can impact your credit score. The score impact depends on your other credit lines and the time since the loan modification.
Based on the last housing crisis, the impact can range between 30 to 100 points downward, according to a paper from the Boston Fed. According to Fannie Mae, a modification could lower your score by 50 points, but that’s still less than a missed payment or a foreclosure—which is 100 points or more.
Lenders may differ in how they report the modification to the credit bureaus. Some continue to state primarily that you’re continuing to pay the total amount on time. Others may report differently, perhaps even as a delinquent account or settled, negatively impacting your scores.
This situation can be challenging. If a loan modification approval condition relies on three trial payments, “those payments are often lower than the original payments, therefore reported as partial payments,” Harris said. “The credit bureaus don't have a code for partial payments, so that information became difficult to input and accurately calculate a credit score. Starting in November 2022, a new credit code is being implemented for trial payments in a loan modification, which should help correct the problem.”
Note
When entering into a modification, ask how the lender intends to report or has reported the situation. If you're still confused about how the loan modification might impact your credit history or a future home equity loan, a HUD counselor may be able to join you for a phone call with the loan servicer’s loss mitigation department to help unravel the situation.
Getting a Home Equity Loan After Modification
In addition to the factors above, lenders have varying appetites for offering a home equity loan if you’ve modified your mortgage. FICO determines derogatory events by tracking how borrowers with similar codes or behavior perform on all their credit lines. FICO picks up special comment codes, which can impact your credit score. Their credit score impact could affect your ability to refinance or the charged interest rate, with higher-risk applicants receiving higher rates.
Waiting Periods
Waiting periods between modification and the ability to receive a new home equity loan may exist for some products or some lenders, in addition to other conditions such as a minimum credit score.
According to Fannie Mae’s policy, a completed modification isn't considered a significant derogatory credit event. There’s no required waiting period following a modification before a borrower is eligible for a new mortgage. FHA guidelines require the borrower to make at least six payments under a new modification before being eligible for a cash-out refinance.
Shopping for a Home Equity Loan
When shopping for a lender willing to lend to someone with a modified mortgage, “I always recommend asking a mortgage broker first, simply because we have access to multiple lenders, so it can provide ease to the homeowner,” said mortgage broker Cameron Cook at C.S.I. Mortgage Design By Cameron in Lone Tree, Colorado.
“The mortgage broker may or may not be able to find a lender to approve the home equity loan, so the homeowner may need to seek out alternative sources,” Cook said. “I would highly advise the homeowner to ask the loan officer to make 100% certain the loan could be approved before any credit inquiries are performed by the lender.”
Additional Requirements
In addition to the above, Harris said the lender might require:
- At least 15% to 20% in home equity
- A credit score of at least 620 or higher
- A debt-to-income ratio below 43% (depending on the loan product)
- An appraisal to determine the true value of the property and how much you can borrow against the home
Other Loan Options
Other options may exist if you can’t get a home equity loan after modification. However, "If your credit is good, your options are better, but if your credit is bad, then those options are limited," Harris said. A few options to explore include:
- Personal loan: Unsecured and secured personal loans exist. For a secured loan, the collateral's value (such as a car or your home equity) determines how much a borrower can obtain. "A personal loan can be a better option if you can secure a lower interest rate," Harris said.
- Home improvement loan: With a home improvement loan, funds may be available faster, you might be able to use your home as collateral, and homeowners with limited equity could have an easier time getting funding. However, disadvantages include fees, higher interest rates, and only being offered to those with a strong credit history. "Lenders tend to set higher interest rates, which can range up to 36%," Harris said.
- CD loan: This loan is secured by your certificate of deposit (CD) account. The lender typically charges you two to three interest-rate points above your current CD interest rate, Harris explained. “This can be a better option if you're looking to get a lower interest rate,” she said.
Before pursuing loans, compare options to find the most favorable, and even "consider whether it’s better to hold off on improvements until you can cover them in cash," Harris said.
The Bottom Line
You’ve probably already been through some financial stress if you've recently completed a mortgage modification. While a loan modification won’t impact your credit score as much as late payments, a foreclosure, or bankruptcy, a loan modification could change your credit score. Ensure your finances are stable before considering additional debt. Keep up on your credit score (and any changes), and speak with lenders to find out what they might be looking for in an applicant regarding a home equity loan or if your modification might hurt your chances of getting a loan.
Frequently Asked Questions (FAQs)
What is the difference between a loan modification and refinance?
A loan modification changes one or more features of your current loan to make it more affordable. For example, the interest rate may be changed or the length of the loan extended to reduce monthly payments. A refinance replaces your current loan with an entirely new one, with its own interest rate, term, and monthly payments.
How long after a loan modification can I buy a house?
Clear guidelines exist for how soon you can qualify for a mortgage after a bankruptcy, but your eligibility for a post-modification mortgage could depend on your loan type (conventional, FHA, VA), lender, or your credit situation. Check with your lender for details.
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