Loan Modification Anatomy

Many homeowners ask about the criteria for obtaining a loan modification through their existing lender. I have successfully assisted dozens of borrowers in obtaining modifications. This article will summarize some of the key characteristics of a successful loan modification request. However, before proceeding through these steps, borrowers may wish to contact their lender about a streamlined modification, particularly if the loan was taken out before 2009 and the interest rate is above 5%

1. Demonstrate Hardship. Homeowners typically seek loan modifications for one of two reasons: (1) they can’t afford their existing payments, or (2) they are behind on their monthly payments and don’t have the resources to catch up all at once. In either case, the homeowner has to be able to show the bank why the payments are not affordable. This could be the result of a job loss, decrease in income, move, increase in HOA dues, unexpected expenses, or increase in payments on an adjustable rate loan, among many other reasons. The lender needs to be shown that the borrower can no longer afford the payments as they currently exist.

2. The Numbers Have to Work. The financial analysis from the lender’s perspective is very similar to the analysis conducted when a borrower initially applies for a loan. Specifically, the lender looks closely at the borrower’s Debt-to-Income (“DTI”) ratio, which is calculated as the homeowner’s total housing payment in relation to their gross monthly income. The total housing payment consists of principal, interest, property taxes, insurance, and HOA dues. Lenders typically believe that a DTI ratio of 31% or lower is “affordable.” So if a borrower has a DTI above 31%, they may be a good candidate for a loan modification.

For example:  Consider a homeowner whose existing monthly PITI payment (principal, interest, plus lender-required tax and insurance escrow) is $1,800. Monthly HOA dues are $200. Total housing cost is $2,000 per month. If the homeowner’s gross monthly income is $5,000, the DTI ratio is 40% ($2,000 / $5,000). Borrowers with a DTI ratio in the 32%-45% range are prime candidates for modifications if they cannot afford their existing monthly payments, since a payment reduction could move them to the affordable range. Lenders will consider modification requests from borrowers with DTI’s of less than 31% if the borrower can demonstrate why there was an interruption in making regularly scheduled payments (which ties into the Hardship requirement above).

3. Complete Submission Package. The loan modification submission package typically consists of an application plus the substantiation of financial information. This requires submission of items such as employment pay stubs, personal bank statements, itemization of monthly expenses, tax returns, a hardship letter, and other items verifying the borrower’s financial status. I recommend that the borrower sign, date, number and include their loan number on each document submitted.

4. Find a Designated Point of Contact. It’s important to identify a single point of contact who the borrower can reach out to in order to check on the status of the modification request. Too often, lenders will not inform borrowers if some document is missing or the information submitted was incomplete. It is imperative that the borrower or their representative be patient yet persistent in following up with the specified lender point of contact. Inevitably, the lender will require additional or updated information as they consider the modification request. The borrower or their representative needs to check in every couple of days to confirm that progress is still moving forward and that the lender does not require any additional information.

5. Temporary Modification Before Permanent. Before extending a permanent loan modification, lenders will typically require borrowers to make three monthly payments under a trial period program in order to verify that the homeowner can meet the proposed monthly obligation. When borrowers make these payments, I recommend that they do so via certified funds and send payments via an easily-traceable carrier such as FedEx or certified mail. This will ensure a paper trail to verify that payments were sent and received before their due date, if ever called into question.

Once a borrower successfully completes the trial period payments, the lender will send a permanent modification agreement. This permanent agreement will document the key characteristics of the modified loan, including revised principal balance, interest rate, term and monthly payment amount. It’s not unusual for a modified loan to be for a term of 30 or 40 years, but not be fully amortized, meaning there will be a balloon payment at the end of the term. This is done so the homeowner can be offered an affordable monthly payment as a percentage of their income.

Contact me if you have questions about the loan modification process or need assistance corresponding with your lender.


Mike Smeenk is an attorney in the law firm of Frascona, Joiner, Goodman and Greenstein, P.C., a Colorado law firm. His practice areas includeEstate Planning, Trust and Estate Administration, Real Estate, and Corporations. Contact Mike Smeenk.

Disclaimer — Content is general information only. Information is not provided as advice for a specific matter, nor does its publication create an attorney-client relationship. Laws vary from one state to another. For legal advice on a specific matter, consult an attorney.