Does Applying for a Mortgage Loan Modification Hurt My Credit?

I received another great consumer question this week.  This one was about the impact of mortgage loan modifications on your credit reports and credit scores.  Here’s the question…

“Are Loan Modifications still having a negative impact on credit scores?  I read somewhere that there was supposed to be a change in how loan mods were reported to the credit bureaus and that this change would protect the consumer’s credit.  Any truth to this?”

This topic has long been a pet peeve of mine since “loan modification” became a household phrase in early 2009.  Just to be clear, a loan modification is when your mortgage lender chooses to adjust the interest rate of your mortgage loan for the purpose of making the new monthly payment affordable.  The hypothesis is that if you can afford to make your monthly payment then you’re less likely to default on your loan.

Initially when loan mods became all the rage in 2009 lenders reported them to the credit bureaus as “partial payment plans.”  Unfortunately, a partial payment plan is considered derogatory in the FICO scoring system.  This meant anyone with that statement on their credit reports would likely see their scores plummet.

In November of 2009 the CDIA (Consumer Date Industry Association), the trade association of the credit reporting agencies, introduced a new way to report loan mods which was neutral in the FICO system.  They were to be reported as a “modification under government sponsored program.”  As long as the mortgage lender reported it this way it did not negatively impact the consumer’s scores.

The News Isn’t All Good

It’s important to remember that a loan modification also has a “trial payment” period where the homeowner is instructed to make a lower monthly payment.  During this trial period the loan is reported to the credit bureaus as being past due because the contractual minimum isn’t being met.  Unfortunately some loan modification applications are taking 6 to 9 months to process…and many are getting denied, which means you’re now at least half a year delinquent on your mortgage loan.  This means you’ll end up with many late payments on your credit reports AND a huge past due balance so your scores will likely be damaged one way or the other.

It’s important that consumers think long and hard about whether or not to apply for a loan modification.  The criteria to qualify requires that you prove you have a financial hardship worthy of the interest rate adjustment.  If you can still make your payment you should not apply for a loan mod simply because you want a lower payment.  You should try and refinance the loan if that’s your goal.

John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit contributor for Mint.com, and the author of the “credit rating” definition on Wikipedia.  He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry.  He has served as a credit expert witness in more than 70 cases and has been qualified to testify in both Federal and State court on the topic of consumer credit.

Categorised in: Credit Report, Credit Score, Money & Identity

This post was written by John Ulzheimer