A loan modification is a permanent change to the terms of a mortgage loan. The goal of taking this step is to lower the payments so that they are more manageable for the homeowner. This is not the same financial remedy as a refinancing loan or a debt consolidation loan.
A refinancing loan may be arranged when the homeowner wants to lock in his mortgage at a lower interest rate. This action will allow him to lock into a three, five, or ten year fixed term rate, which means his payments will remain at the same level for until term they have chosen expires. A debt consolidation loan allows the homeowner to take credit card and other debt and add it to his mortgage. The resulting payment will be lower than trying to make a payment to each creditor separately.
A loan modification makes sense when there has been a change in the homeowner's financial circumstances. The borrower will be asked to provide evidence of the reduction in monthly income. Negotiating a loan modification means that the homeowner can avoid foreclosure and stay in the home.
Any principal, interest, or fees owing on the mortgage at the time the loan modification is arranged will probably be added to the loan amount, so that the lender doesn't have to take a financial hit. The homeowner needs to keep in mind that he or she will be paying interest on these amounts as well. With a new mortgage, very little of the principal gets paid down for the first several years, which will add several thousand dollars to the costs of borrowing.
From the point of view of the lender, loan modification makes sense. The lender doesn't have to go through the process of foreclosing on the property and trying to find a buyer for it. There is no guarantee that the lender will be able to recover the full amount of the original mortgage if the property is sold after foreclosure has taken place.
A loan modification arrangement makes good sense to homeowners as well. It's an opportunity for them to adjust their housing expenses so that they are more in line with their new financial reality. A change in financial circumstances can happen to anyone if they become unemployed or ill and unable to work. Working with the lender to arrange a more affordable mortgage payment makes good sense when earned income has dropped.