Loan Modifications and Credit Scores

 

We have been asked by several professionals to focus on Loan Modifications and how they affect the credit scores. As usual there is much contradictory information about the affects of a loan mod.

What is a Loan Modification?

Modifying an existing loan made by a lender in response to a borrower’s long-term inability to repay the loan. Most Loan modifications involve a reduction in the interest rate on the loan, an extension of the length of the term of the loan, a different type of loan or many of these choices. Lenders are open to Loan mod’s because it will cost them less than the alternatives.

According to www.myfico.com the scores will not be affected if the loan has the same original account number. The balance, terms duration (length of time mortgage is paid for), and monthly payment amount will change based on the new information agreed upon by the bank.

A totally new account will decrease the score. As we know closing and opening credit can reduce scores as much as 60 points (past articles can be reviewed on our website). So if a new loan is reported and the old loan is closed the scores will take a big hit for at least a year. The site mentions nothing about partial payment plan. From what I have studied I believe they are discussing loan mod’s that are not part of the “Making Home Affordable Plan”.

According to Fico Forums where loan modifications are discussed ,and responses managed by a Fico expert moderator, it is acknowledged that a partial payment agreement will be updated on the credit reports and reduce scores dramatically. These responses are directly related to the “Making Home Affordable Plan” created by the government. These loans are government owned loans and not all loan modifications fall into this category.

According to the CDIA (CONSUMER DATA INDUSTRY ASSOCIATION) the loan modification candidate must make partial payments on the loan for a trial period of 3 months, or more, depending on the situation.

To qualify for the governments “Making Home Affordable Plan” the 3 months is required for acceptance into the modification program.

You can read more at http://makinghomeaffordable.gov/.

Since the loan is not being paid as it was agreed the credit bureau will update it as “partial payment plan” or “modified payment agreement” which is a negative to the scores. It could drop the score as much as 100 points depending on your overall credit profile.

We see this often when consumers go into debt consolidation programs. These programs are given by non for profit organizations that work directly with the creditors to reduce interest rates on debt and increase the length of time debt can be paid off by consumers. They mark the credit report under each account “debt consolidation repayment plan” or “in debt consolidation payment plan” and even though these accounts may have never been late they are still considered derogatory if they are in a partial payment plan.

It does make sense if you think about it. You are now paying back the debt but not at the original agreed upon terms. Remember, as always, the higher your score is before you have a delinquency the greater it drops when the new update is reported by the bureaus.

The partial payment plan mark is considered derogatory and the score will plummet.

Here is what the CDIA said exactly:

”Mortgage Loan Modification Program – Freddie Mac and Fannie Mae”

“Freddie Mac & Fannie Mae are offering a streamlined modification program starting 12/15/2008 for a targeted group of borrowers with certain loan criteria. As it relates to credit reporting, all eligible loans under this program must be at least 3 payments delinquent. The consumer must first make 3 payments (reduced payments) during the 3-month trial period before the loan modification will be made effective. During that time, the data furnisher should report the true Account Status Code, which is delinquent, and Special Comment AC (Paying under a partial payment agreement). “

My interpretation after reading through much of the CDIA info: It seems that the 3 trial payments are the 3 late payments they discuss that are required and reported as delinquent. You don’t have to be late 3 times prior to the 3 trial payments. Read more at http://cdia.files.cms-plus.com/Metro2/MortgageLoanModificationProgram.pdf.

To summarize the studies we have found:

If you go into a loan mod through the “Making Home Affordable Plan” you will most likely have a great decrease in your credit scores. There are times that banks just make mistakes and don’t update to the credit bureaus. If this happens consider yourself lucky in at least one aspect of the situation. If you go through a loan mod with a bank that is not a part of the MHAP plan your credit will reflect the way My Fico defined the credit update. As long as it is the same loan and account # you will see minor or NO change in the credit score.

So far we have not come across 1 report showing “partial payment plan” for a loan modification but that does not mean it isn’t happening. It stands to reason we will be seeing an enormous amount of these in the next few years when consumers want to begin to rebuild and improve their credit scores.

Copyright ©2009 North Shore Advisory Inc.



Comments are closed.