Does a Mortgage Modification Hurt Your Credit?

It can, but there are ways to minimize the damage

Fact checked by Betsy Petrick

When you experience financial hardship, you may find it difficult to keep up with your monthly mortgage payments. In this case, you could request a mortgage modification from your lender that will result in more affordable payments.

But while a mortgage modification can provide welcome financial relief, it can also have a negative impact on your credit score. Exactly how much depends on the circumstances surrounding the mortgage modification and the steps you take next. Here is what you need to know.

Key Takeaways

• In a mortgage modification, the lender changes one or more features of your loan to make it easier to pay.
• A mortgage modification can have a relatively immediate negative effect on your credit score, but the long-term impact depends on several factors.
• Understanding your lender’s modification terms is crucial for minimizing the negative impact.
• Regularly monitoring your credit report post-modification can help you identify and correct any inaccuracies.
• A past mortgage modification may make it more difficult to obtain a mortgage or other loan in the future, but the damage can be mitigated if you take the right steps.

Understanding Mortgage Modification

Mortgage modification is just what it sounds like, but it can take a number of different forms.

What Is Mortgage Modification?

A mortgage modification occurs when the lender agrees to change the terms of your original loan. This could mean lowering the interest rate, extending the term (or length) of the loan, or reducing the amount you owe. The goal is make your monthly mortgage payment affordable so you can continue to pay it. 

There are several other ways to accomplish that goal, but they differ from mortgage modification in key ways:

• Refinancing. While a mortgage modification changes the terms of your current home loan, a refinance involves an entirely new loan that pays off and replaces your old loan. 
• Forbearance. With forbearance, your payments are temporarily paused or you pay a reduced amount, but for just a limited period of time. 

Why Homeowners Opt for Mortgage Modification

The most common reason homeowners may seek a mortgage modification is financial hardship. If they’ve lost their job, accumulated large amounts of debt, or had to pay for unexpected expenses such as medical bills or major car repairs, they may not have the cash they need to cover their monthly mortgage payment. 

Life changes also could make it difficult to pay the mortgage loan as agreed. For instance, if the homeowners divorce and one party receives the house, he or she may find it difficult to maintain the mortgage payments on one income. The same could occur following the death of one of the homeowners. 

How Mortgage Modification Affects Credit Scores

If you have trouble paying your mortgage and decide to move forward with a mortgage modification, it could affect your credit score. Some of those impacts may be negative, but others could be positive compared with the alternatives.

Immediate Impact on Credit Reports

If your lender reports your mortgage modification as a settlement, meaning you are paying less than you owe, that could appear on your credit reports as a negative. Settled accounts can stay on your credit reports for up to seven years. The information on credit reports is used to calculate your credit score, so it will affect your score, as well.

Mortgage Modification and Credit Score Factors

Lenders typically don’t approve a mortgage modification until the borrower has a history of missed payments. Payment history accounts for the largest portion of your credit score, so every missed payment will damage your credit score even before you apply for modification.

Comparing the Impact: Mortgage Modification vs. Foreclosure or Bankruptcy

As mentioned, with a mortgage modification, your credit score could take a hit due to late or missed payments. If the lender reports the modification as a settlement, that could remain on your credit report for seven years, also affecting your score. However, your credit score could begin to rebound once you start making on-time payments on the modified loan. 

If your mortgage goes through foreclosure, your credit score will likely drop due to the missed payments that led up to it. Foreclosure is the legal process a lender uses to recoup what the borrower owes if they default on their mortgage. The lender becomes the property owner and can sell it. Once a loan is foreclosed, that will remain on your credit report for seven years from the date of the foreclosure and is typically more damaging than a settlement. Rebuilding your credit could take much longer than with a modification. 

If you file for bankruptcy, the impact to your credit score could be huge and long-lasting. It’s possible your credit score could drop as much as 240 points after bankruptcy. In addition, the bankruptcy may remain on your credit report for up to 10 years, which could affect your future ability to obtain credit.

Warning

Beware of loan modification scams. Some unscrupulous individuals or companies will promise to help you obtain relief, charge you upfront, and simply make off with your money.

Steps to Minimize the Impact on Your Credit

While a mortgage modification could negatively impact your credit, there are steps you could take to reduce that impact. 

Communicate With Your Lender

If you have concerns about paying your mortgage, contact your lender right away. Talking with the lender could help you find a solution before you have any late or missed payments, which will protect your credit score. 

Understand the Terms of Your Modification

It’s important to familiarize yourself with the modification terms so you know how they may affect your credit. For instance, if your lender plans to report your loan modification as a debt settlement, that will likely have a negative effect.

Also, if your mortgage modification includes a forbearance, find out whether the lender will report those paused payments as delinquent on your credit report. Doing so will lower your credit score, so ask your lender to refrain from reporting those payments as missed if at all possible. 

Monitor Your Credit Report

As you work to rebuild your credit, it’s important to regularly check your credit reports with the three major credit reporting agencies—Equifax, Experian, and TransUnion—for errors or inaccuracies that could affect your credit score after a modification. You can get free copies of your credit reports at least once a year through the official website, AnnualCreditReport.com.

If you spot a mistake, follow the credit reporting agency’s procedures for reporting an error. It is required to investigate and get back to you. Continue to monitor your report to ensure the correction has been made. 

Long-Term Considerations

When contemplating a mortgage modification, it’s important to understand not only the immediate impact but how it will affect your credit in the future.

Rebuilding Credit After Modification

Once your mortgage modification is complete, the best step you can take to rebuild your credit is to consistently make on-time payments on your mortgage and any other credit accounts. One way to make that a little easier is to arrange for automatic payments from your checking account.

Also, try to keep your credit utilization ratio low. That’s the amount of revolving debt you have outstanding compared with the total amount of revolving credit you have available to you.

Future Mortgage Applications

If you follow the terms of a mortgage modification and pay the loan off as agreed, getting a mortgage in the future should not be major problem provided you meet the eligibility requirements for the loan. 

How Long Does a Mortgage Modification Stay on Your Credit Report?

If the lender reports your mortgage modification as a settlement, it could remain on your credit report for seven years.

Can You Refinance Your Mortgage After a Modification?

You may be able to refinance your mortgage following a modification, but the lender could require you to wait for a certain period, such as a year, before doing so. 

How Does a Mortgage Modification Compare to a Loan Forbearance in Terms of Credit Impact?

There could be similar impacts on your credit with a modification and a forbearance. If the lender reports the missed payments with a forbearance, that could have the same negative affect on your credit as the missed payments led up to the modification. 

The Bottom Line

A mortgage modification can be helpful if you are finding it difficult to make your monthly mortgage payments. While a mortgage modification can affect your credit, the impact can be managed and mitigated. In particular, make sure to pay your mortgage bill on time every month.

Read the original article on Investopedia.