One concern that many people have about getting a mortgage loan modification is how it will affect their credit rating. They may be in a position where a loan modification would help them, but they hesitate to pursue one for fear of harming their credit.

At first, it might seem a minor issue. After all, a foreclosure is one of the worst things that can happen to your credit rating, so doing what you can to avoid it might seem like a no-brainer. But for those who depend on good personal credit - such as small businesspeople who need to maintain a healthy credit line to keep operating - there might be legitimate reasons to be concerned.

Long-term credit impacts may be positive

The fact is, there's no simple answer. Depending on how your lender reports it to the credit bureaus, a loan modification can result in a drop in your credit rating. But at the same time, it's going to have far less negative impact than a foreclosure or string of late payments, so in that case, it can actually help your rating in the long run.

In most cases, borrowers seeking a loan modification are already going to be in some kind of financial difficulty. Many will have already begun missing payments or making late payments (defined as 30 days or more late for credit reporting purposes), so they're already suffering some negative effect on their credit rating.

In fact, some lenders may not consider a loan modification until a borrower begins to fall behind on their mortgage, although this is not the case of all lenders or a requirement of the government's Making Home Affordable program.

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May be reported as a debt settlement

Lenders will often report a loan modification to credit bureaus as a type of settlement or adjustment to the terms of the loan. If it shows up as not fulfilling the original terms of your loan, that can have a negative effect on your credit. But the effect will be less and of shorter duration than a string of missed payments or a foreclosure would have.

On the other hand, some lenders may not report a change as a settlement, meaning your credit would be unaffected. In this case, your credit rating could even improve, because your monthly payment would be reported as decreased. When negotiating a loan modification, ask your lender how they report it - they may even agree not to report it as an adjustment, particularly if you've been a good customer over the years.

One particular credit problem has been associated with trial loan modifications under the government's Making Home Affordable Program. In a trial modification, the homeowner is given a reduced payment schedule which, if maintained for three months, can be made permanent. However, some homeowners are reporting that their lenders are reporting them as failing to stay current on their payments during this period, since the reduced payment schedule is not yet official.

Trial modifications should be listed as current

The government has issued guidance to lenders that trial modifications should be listed as current, but on a modified schedule. This may still have a negative impact on your credit, but will not be as severe or last as long as a late-payment report. If your lender is not reporting your modified payments as current, you or your credit counselor can refer them to the guidelines posted on the Home Affordable Modification Program - Administrative Guidelines for Servicers website.

Finally, it's important to remember that at loan modification will likely have a different impact on your credit than refinancing your mortgage. A loan modification changes the terms of your existing mortgage, while a refinance is simply obtaining a new mortgage on better terms. A refinance should have no negative effects on your credit, other than possibly a small short-term dent due to the fact you've taken out a new loan. But otherwise, the effects should be minimal.

Published on July 17, 2009