Struggling homeowner should be aware that any modification to their loan terms will affect their credit score. Mortgage representatives should inform borrowers of this before they proceed with a modification, but too many times borrowers are surprised to see their credit score drop by 100+ points.
Loan Modifications and Credit Scores
Borrowers, who need a modification or extension on their credit, by definition, cannot afford their current debt levels. It would stand to reason that their credit score should reflect this fact. Borrowers with high credit scores can expect to see their credit scores drop by 50-100 points once they enter into a loan modification. It is important to note that scores do not drop if a borrower simply applies for a modification. A borrower must enter a program to have their payments deferred or receive some kind of debt reduction to see their scores lowered.
Credit scores reflect the borrower ability to take on additional debt. An extremely high credit score implies that a borrower can afford to take on additional debt, without a significant change to their lifestyle and income. Low credit scores imply the opposite that a borrower cannot afford to take on additional debt without significantly changing their lifestyles or substantially increasing their income. When banks report a loan modification, they not only report the late payments, but they also report that the borrower is no longer paying the full amount of the required payment. Combined, these items significantly damage borrowers’ credit scores.
Should Borrowers’ Modify Mortgages?
Given the aforementioned credit score effects, it begs the question should borrowers, who can pay their mortgages, apply for modifications? In most cases the answer is yes. Borrowers feeling the pinch and strain of bill payment should proactively seek to lower their payments. Yes, they will suffer a credit score hit, but in the long run, they will be able to stay in their home and have more available income in case their financial situation deteriorates further. If the financial crisis has taught borrowers anything, it is that their economic situation can change and change rapidly.
Saving an extra $500+ per month could amount to a significant savings over time. While this may prevent borrowers from obtaining another mortgage for the next several years or increase their cost of financing, the short-term benefits outweigh those issues.
Borrowers seeking loan modifications should look to lower their total debt, instead of concerning themselves with their credit rating. Using the savings to pay down credit cards, second mortgages and home equity loans will more than make up for the negative effect on their credit score.
Michael Cook - Michael Cook is currently a Real Estate Investment Banker for Wachovia. He and his partnerstarted their own real estate investment ...
