When a tornado veers towards your neighborhood, you must choose the course of action with the fewest negative consequences. Generally, this means grabbing some canned foods and heading for the basement. The same rule applies when you can't keep up with your mortgage payments. To keep your home, you may have to proceed with a loan modification, even if that means your credit score (FICO) will suffer.

The potential credit score impact of a mortgage loan modification is somewhat complex. One thing, however, is clear: you won't have the opportunity to clarify exactly how your modification will play out on your credit report ahead of time. If you're worried about it, remember that your other option is foreclosure. And foreclosure will always drag your FICO down more than a modification will.

Know the code

The way your lender chooses to report your mortgage loan modification largely determines the impact to your credit score. When the foreclosure crisis first began, many lenders were documenting modifications with the code "AC." These letters have historically been used to indicate partial payments. Since partial payments are indicative of future delinquencies, an AC notation in your credit file will pull down your credit score. In January of 2010, The New York Timesblog quoted a Treasury spokesperson who estimated that an AC's negative impact would be between 30 and 100 points.

In 2009, the credit reporting agencies created a new code specifically for mortgage loan modifications. This code -- "CN" -- indicates that the loan has been modified under a federal program like Making Home Affordable. Now, lenders typically report modifications with CN rather than AC.

As of August 2010, CNs do not impact FICO scores at all. There is the chance, however, that this may change. If the credit scoring folks establish a link between loan modifications and future delinquencies, then they would roll CN into the FICO calculation.

Be aware that the lender could use a CN code initially, but then later report that you aren't making payments as agreed. You should, therefore, stay current on your payments and keep tabs on your credit report. If you see comments in your credit file that are unwarranted, take it up with your lender in writing.

Same loan vs. new loan

A secondary issue is whether the lender reports the modification as changes to your existing loan, or as closure of the old loan and opening of a new one. The routine activity associated with replacing an old account with a new one generally has a negative impact on credit scores. The modified mortgage would be newer than the original mortgage, which will shorten the active credit history. (The length of your credit history accounts for 15 percent of the credit score calculation.)

At the end of the day, you may face some credit score impact from your mortgage loan modification-just as that tornado might peel the roof off your home. In either case, deal with those consequences first, and then set your sights on repairing and rebuilding.

Published on August 26, 2010