Loan modification programs allow individuals to revisit the terms of a loan. The most common types include forbearance, loan extension, interest rate reduction, partial claim, principal deferral, and repayment plans. Each of these programs assist borrowers and lenders in reaching new loan terms that will benefit both parties. Loan modification programs are generally considered preferable to defaulting on a loan.
A forbearance loan modification program allows a borrower who is experiencing a temporary financial hardship to remain current on the terms of a loan. Under this type of program, the lender will suspend or reduce loan payments for a temporary period of time. When the forbearance term ends, the lender will expect the borrower to repay the difference, either through installment payments or through one large lump sum payment.
A loan extension, also known as term extension, is a loan modification program that extends the term of a loan. For example, a homeowner may seek to amend a 30-year mortgage loan to instead be paid over a 40 year period. Though this program commonly reduces monthly payments, the additional interest from payments made over an increased period of time will likely result in a higher total payment.
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An interest rate reduction is one of the most common types of loan modification programs. Also known as reduced rate modification, it typically allows a borrower to reduce the monthly payments associated with a loan. Interest rate reductions can be a short-term or long-term solution. The amount the lender loses in unpaid interest as a result of this modification will generally be added to the principal amount.
Partial claim loan modification programs are for borrowers who are at least four months behind on their mortgage payments, and are able to prove that a financial hardship exists. In the US, these programs are often seen on Federal Housing Administration (FHA) loans. In order to resolve the issue without defaulting, missed payments are rolled into an additional loan that is added as a second mortgage. Payment of the second mortgage is usually collected when the loan is refinanced or the property is sold.
Another common loan modification program is loan principal deferral. This type of modification lowers the monthly payment by deferring part of the principal. The deferred amount will be due when the loan matures, when the loan is refinanced, or when the property sells.
Repayment plans may be arranged for borrowers who are delinquent on their loans. These plans allow the borrower to repay a loan through installments, rather than paying one lump sum. A down payment, or percentage of the total amount, is generally required at the beginning of this process.