The focus of loan modifications is to help people facing foreclosure save their homes. Through the Making Home Affordable Modification Program and many other programs the modifications are accomplished by lowering the monthly payments on loans to amounts that the people can afford to make. The mortgage company normally does this by lowering the interest rate on the loan.
While it may enable a person to save their home from foreclosure, lowering the monthly payment can have a negative impact on them in another way. It may adversely affect their credit score.
When the person facing foreclosure negotiates a modification and pays the amount agreed to, they are actually paying less than the amount they agreed to pay originally when they got the loan. Technically the credit bureaus view that as settling the account for less than the full amount.
In the past many people with high credit card balances who had difficulty making payments sought help from credit counseling firms. These firms would contact the creditors and negotiate a lower balance on each account. The creditors in effect would be eliminating some of the interest which had accumulated on the accounts. The credit counseling firms would also negotiate a lower monthly payment on each.
On their part the creditors would close the accounts so that the people could not charge any more on those accounts. As the people made their reduced monthly payments, the creditors reported to the credit bureaus that they were paying less than the full balance owed.
The credit bureaus created a separate category for these accounts. They updated the accounts showing that the payments made were less than what was owed. They also considered these people a greater credit risk. Because of the greater risk the credit bureaus reduced the credit scores of these people.
Let’s fast forward to today. The person facing foreclosure who negotiates a loan modification and starts to pay a lower amount monthly is in the same category as the people for whom the credit counselors secured reduced payments. The mortgage companies are now reporting that these people are paying less than the full amount owed.
When the credit bureaus are notified of this, they lower the person’s credit scores. Large mortgage companies, such as, Citigroup, JP Morgan Chase and Bank of America are doing this. Most probably the smaller mortgage companies are doing the same.
Who are hurt most by this? Those people who have not fallen behind on their monthly payments but requested a loan modification because they knew that there was no way they could continue to make their payments.
One example is the person whose income is reduced drastically. That could happen because they lost their job and had to take one for less money or their employer suddenly cut their income substantially. Another example is the person who becomes totally disabled and whose income is reduced significantly. These people may see their credit scores drop as much as 100 points or more.
The credit scores for those people who had already fallen behind on the monthly payments would have already dropped. Their credit scores would drop more but not as much as those of the person who never was late
What is the big concern about the drop in credit scores?
We have become a credit score driven society.
A person’s credit score determines whether or not they can get a credit card. It also determines what interest rate they have to pay on that card. A low credit score may disqualify them from getting a card. If they can get one, the interest rate may be very high.
The same is true for auto loans. People with low credit scores have difficulty getting loans. When they can get a loan, the interest rate is very high.
Credit scores also determine how much a person pays for auto and home owner’s insurance. People with lower scores are viewed as high risks and their rates are higher.
Some employers are even looking at credit scores of people applying for jobs with their companies. They frequently view people with lower credit scores as less desirable candidates for their open jobs.
Let’s come back to the person facing foreclosure who gets the loan modification. One major factor in determining the monthly payment they can make is the amount of monthly debt they have. That is reviewed at the time they apply for the modification.
If the modification is approved and they start making the lower monthly payment, their mortgage company is going to report them as paying less than what was agreed to. The credit bureaus are going to lower their credits cores. Their monthly payments on credit cards and auto loans are going to increase. Their premiums for auto and home owner’s insurance are going to rise.
Within a short time their monthly payments have increased again. They are in danger of not being able to make the monthly payment on their loan again. Is there any sense in that?
In November of 2009 the credit bureaus will create a separate category on the credit reports for people who get loan modifications. This will indicate that the borrower’s loan was modified under a federal government plan. The company which developed the credit scoring system may do a study to see if these people are truly a greater risk than others and what impact there should be on their credit scores.
What happens to those people now whose credit scores are adversely affected? Will there be any adjustments to their credit scores?
What if in November of 2009 the credit bureaus start to put a notation on their reports that the borrower’s loan was modified under a federal government plan but no change is made to the way their credit scores are impacted?
We cannot wait to see if the credit bureaus and the company which developed the credit scoring system take the steps to correct what is happening to those people whose loans are modified. The longer we wait the more likely it will be that people who get loan modifications will suddenly see their other payments increase. They may fall behind on the monthly payments and face foreclosure again.
Send a letter to your congressman and your senators. Bring this matter to their attention. Ask them to get involved and to make sure that people who are given loan modifications are not victimized.