As a homeowner, you have many options to help avoid default and outright foreclosure. Three of those options include loan modifications, forbearance agreements, and repayment plans. Understanding the difference between them, and in what situations they are appropriate, will help you make an informed decision that's right for you.
A loan modification changes the terms of your mortgage loan to help you get caught up when you've fallen behind. There are three specific terms of a mortgage loan that can be modified: the interest rate, the length of the loan, and the principal amount.
If you've fallen behind on your mortgage due to financial hardship, a loan modification is a great way to get caught up without more extreme measures, provided the financial hardship does not take away your ability to make your mortgage payments.
Interest Rate Modification
One of the most common loan modifications a financial institution makes is to the interest rate. They might offer a rate reduction, or they might offer to change a variable rate to a fixed rate. In either case, the intent is to reduce the monthly payments and allow you to catch up on your mortgage loan.
Loan Length Modification
Another common modification your mortgage company might offer is to extend the length of your loan. Most mortgages are 30-year loans, so your financial institution may offer to extend the loan to a 35- or 40-year mortgage to lower the payment and help you catch up.
Principal Amount Modification
This option is not one most mortgage companies start with, but in specific circumstances, they may agree to lower your principal amount. This is usually done in extreme financial hardship situations, and there may be specific stipulations required to get this modification, but of the three, it is the most beneficial to you, the homeowner.
If loan modifications are not enough to help you get back on your feet, another option a lender might consider is a forbearance agreement. With these agreements, the lender temporarily reduces or suspends payments, allowing you a reprieve to get your finances in order. At the end of the forbearance period, payments resume as normal.
It is important to understand your lender's specific requirements before agreeing to forbearance. Although a three-to-six month period without payments might offer you a reprieve, it doesn't come without consequences. For example, the interest may continue to accrue and be added to the end of the loan, you may have a lump sum payment due at the end of your forbearance, or you may be required to increase your monthly payments slightly at the end of your forbearance to make up for the period you skipped.
Forbearance agreements are best suited for individuals who had a temporary financial setback, such as loss of income for a short period of time. It will not help you if you are paying on a house you can't afford.
Repayment plans are great for those who missed one or two payments due to a temporary hardship. In this scenario, a lender may agree to spread out the past due balance over a certain number of months, allowing you to catch up while still keeping your loan current. This helps you avoid further late fees and additional penalties, too.
Repayment plans are not well-suited for homeowners with long-term financial hardships, and it may be better to consider one of the other options if the hardship is expected to continue. However, if you or a spouse had an unexpected short-term loss of income but are now back on track, then this option may make the most sense for your situation.
At the end of the repayment period, your mortgage payments return to the normal amount listed under the original mortgage agreement, and your loan will be considered current. As with any of these three options, repayment plans are not suited for homeowners who own more home than they can afford.
All three options provide homeowners with some relief or assistance in making their payments, and some are better than others. However, as we've mentioned, none of these options will help you indefinitely. It's important to choose a home you can comfortably afford, and we also recommend going a little under that to ensure you'll be alright in the event of a financial hardship.
If you're struggling to make your mortgage payment, take a serious look at your financial situation and determine if you're behind because of a hardship, or because you took on more debt than you could afford. It's much easier to make a decision when you know where you stand financially, and it puts you in control when you call your lender to negotiate.