How Do Loan Modifications, Other Measures Affect Credit?

Kirk
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Kirk Haverkamp
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Probably the most confusion surrounds loan modifications. That's when the lender agrees to modify the terms of your mortgage to make it more affordable or perhaps help you get current again on your loan after a temporary financial difficulty.

Technically, a loan modification should not have any negative impact on your credit score. That's because you and the lender have agreed to new terms for paying off your loan, so if you continue to meet those terms, there shouldn't be anything negative to report.

Probably the most confusion surrounds loan modifications. That's when the lender agrees to modify the terms of your mortgage to make it more affordable or perhaps help you get current again on your loan after a temporary financial difficulty.

Technically, a loan modification should not have any negative impact on your credit score. That's because you and the lender have agreed to new terms for paying off your loan, so if you continue to meet those terms, there shouldn't be anything negative to report.

However, you will suffer some damage to your credit rating if you missed a few payments or made some partial payments in the months before your loan modification was approved. If that's the case, those the Consumer Data Industry Association missed or partial payments will damage your credit, but the loan modification itself will not.

There have been some problems with damaged credit for people who have obtained loan modifications under the government's Making Home Affordable Program. In that case, the problem is that borrowers obtaining loan modifications must undergo a three-month trial period at the new, reduced payment level before their loan modifications are finalized.

In many cases, these trial payments were reported to credit bureaus as partial payments, because the new payment schedule had not yet been fully approved. Part of the problem is that credit bureaus didn't have a code to represent trial payments, so lenders were told to report them as partial. Starting in November, though, a new credit code is being implemented specifically for reporting trial payments in a loan modification program, which should help correct the problem.

Refinancing should not affect credit

If you simply refinance your mortgage at a lower rate to reduce your monthly payments, you shouldn't have any negative credit impacts at all. Refinancing your mortgage is basically paying off your existing mortgage by taking out a new one, so there's nothing negative to report. In fact, you'll need good credit to refinance your mortgage in the first place.

One place a mortgage refinance might have a negative impact is if you try to take out another large loan, such as a car or boat purchase, within a few months of refinancing. Since the refinance is a new major loan, lenders may look askance at you seeking to take out another so soon, even though you've actually reduced your debt obligations.

Another way a refinance might damage your credit is if you do a short refinance. In this situation, your home has lost value and the lender agrees to write down the principal and issue you a new loan. You're basically doing a short sale (see below) to yourself. This is typically a difficult arrangement to obtain, although in the current market environment, lenders may be more accommodating than in the past. Still, it's going to show up on your credit score as a debt writeoff for the next seven years.

Short sale recorded as a writeoff

A short sale, mentioned above, is when the lender allows you to sell the property for less than the balance owed on the mortgage in order to avoid foreclosure. This is sometimes an attractive arrangement lenders, because the marked-down value of the property still exceeds what they could expect to get out of a foreclosure sale and is far less costly to process as well. Still, it goes on your credit score as debt writeoff, though the impact is considerably less than a foreclosure itself.

A deed in lieu of foreclosure is when a homeowner who can no longer afford mortgage payments simply signs the property over to the lender. Opinions on this are mixed. Some claim it's better for your credit than a straight-out foreclosure, because you're ending the foreclosure process early and reducing the number of missed payments that show up on your record. Others say it's basically the same thing as a foreclosure and will have basically the same credit impact. Either way, it stays on your report for seven years.

A foreclosure has the most severe impact, although the impact will be far greater on someone with good credit than someone whose credit was already damaged. A foreclosure can drop your credit score as much as 200-300 points and stays on your credit report for seven years, although the initial impacts do moderate over time.


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