What is Loan Modification?

Malcolm Tatum

Loan modification is a finance option that involves the process of altering the terms and conditions that apply to a loan that is currently in force. The loan in question may be a mortgage or other type of home loan, or even a business loan or personal loan extended by a lending institution. In all situations, the loan modification is only extended after the lender has reviewed the current situation and determines that altering the existing loan is in the best interests of all concerned parties.

Businessman with a briefcase
Businessman with a briefcase

One of the most common reasons for a loan modification involves some type of financial reversal that impacts the ability of the borrower to continue making payments according to the current schedule. This reversal may take place due to various types of hardship, such as losing a job or an unexpected illness that creates large doctor and hospital bills. Whatever the reason behind the economic change for the borrower, circumstances make it clear that it will not be possible to continue making payments according to the provisions associated with the loan.

When approached by the borrower, the lender will often begin to explore the different options. One would be to declare the loan in default and claim any collateral associated with the loan. However, this is a process involving time and legal expenses. Assuming that the borrower was diligent in making payments up to the point of the financial reversal, the lender may choose to consider modifying the conditions of the loan in order to maintain the relationship.

The loan modification may include altering any of three different components of the current loan. The amount of the monthly payment may be reduced to a figure that the borrower can reasonably manage. While this means altering the terms to include additional payments on the back end, the borrower does not have to worry about a negative impact on his or her credit rating, and the lender regains confidence in the ability of the borrower to honor the obligation. The lender may also make adjustments on the rate that is applied to the loan, reducing the amount of interest that must be paid on the loan.

Generally, a lender will not consider the option of a loan modification unless there is evidence that the borrower will be able to make timely payments under the revised terms and conditions of the loan. For example, if the borrower has a new job lined up to begin in a few months, the lender can be reasonably sure the borrower will overcome the temporary financial crunch. If health issues are temporarily impacting the ability of the borrower to meet the current monthly payment and those issues are expected to be resolved in a relatively short period, the lender is also more likely to consider a loan modification.

In all cases, the lender is highly unlikely to engage in a loan modification if the borrower has not been diligent with making payments in the past. Since the lender will have little or no confidence in the borrower’s ability to honor the adjusted terms, it is much more likely the loan would be called and a default would take place.

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