During the Financial Crisis of 2008 and beyond, many homeowners found themselves upside down in their primary residence: they owed more on their mortgage than the value of their home. Lenders came up with a possible solution to offer consumers a loan modification. How did a modification impact their FICO® scores and their finances? There is something critically important to know before anyone goes down this path.
Hundreds of thousands of homeowners were offered a loan modification in hopes of keeping their payments on-time. In most cases, a loan modification allowed homeowners to lower their payments for a period of time or even skip a few payments until the end of the loan.
There was a big problem that many homeowners did not know until months and years later. There are two factors in calculating FICO scores that will drop FICO scores 50 to 60 points on average. In addition, past loan modifications had a great impact on such homeowner’s ability to get a mortgage for several years.
What Happens to a Mortgage When Payments are Skipped or Modified?
If someone has a mortgage payment of $1,500 and he / she runs into employment or other financial problems, such person is encouraged to complete a modification application with the mortgage lender. This can take several weeks and even a few months to gain approval. If approved, a lender grants a modification to the loan payment. In this example, the lender drops the loan payment to $1,300 for 12 months.
Or you notify the lender that you lost your job. You ask the lender to skip a couple of mortgage payments and add them to the end.Both situations sounds workable – right? However, there’s a bigger problem looming that can impact FICO scores and finances for years to come. Many consumers have later discovered that if they would have known the true impact to their finances from a loan modification, they would have never agreed to it.
The Difference Between a Satisfactory and a Derogatory Account
The credit bureaus classify a satisfactory account as one which a consumer has made payments on time over the last seven years. A derogatory account is an account when a consumer has had at least one 30-day late payment, payments have been made less than what was originally agreed in the loan documents, or any changes to extend the payments on the loan.
The lender does not have to report a 30-day late payment to show the account as a derogatory account.
When a lender reports your account information to the credit bureaus, that lender reports how many 30-day, 60-day or 90-day late payments. Under a separate category, the lender also reports if the loan is a "Derogatory Account". If payments have been modified or change, most lenders will change this reporting in such accounts as a derogatory account.
Why Does this Matter?
FICO has two issues from a loan modification that most always lower a consumer’s FICO Scores. They are, Number of Accounts with Delinquency (FICO #18)and Amount Owed on Delinquent Accounts (FICO #34).
Number of Accounts with Delinquency
How many is too many that it will drop your FICO Scores? One.
So having a mortgage skip a payment (even though it is agreed to by the lender) will most likely lower your FICO scores from this issue – even if there are no 30-day late payments reported. Having not make the same payment that were agreed upon when the note was signed classifies this loan as a derogatory account. The drop to FICO scores from this issue can be 20-25 points.
Amount Owed on Delinquent Account
How does this factor impact FICO Scores? Whenever a derogatory account has a balance, it lowers FICO scores. A mortgage is usually a large balance. The drop to the FICO scores from this issue can be 25 to 30 points.
The Drop to FICO Scores
Add both issues up and you can easily see a drop in the FICO scores of 50 to 60 points from a loan modification with a mortgage. Why did not the federal government step in and address this? They had other more pressing issues other hands. Second, the federal government was generally unaware of the impact to the consumer's FICO scores. There is a lot of complexity here and the government just did not know that even though late payments were not reporting on a loan modification, the drop to the FICO scores occurred from the derogatory account status.
A Second Future Concern
Many consumers who had a modification soon discovered that they were ineligible to refinance their mortgage to a lower interest rate. Most mortgage lenders prohibited a new mortgage from anyone who had a past loan modification.
In addition, the borrower was ineligible to purchase another home and taking out another mortgage.
This problem went on for four to five years after the modification. Such consumers were basically stuck in tehri mortgage unless they wanted to sell their home and rent. It was not until about 2016 / 2017 that mortgage lenders started dropping their restrictions on past mortgage modifications.
What to Know?
If you have no choice but to skip a mortgage payment, take advantage of this opportunity. Ask the lender for a letter certifying that skipping a mortgage payment will not impact your credit. This can give you some possible protection in case you discover your credit has been damaged.
Get documentation if you can from the lender protecting your credit!
If you can still make your payment, you would be wise to most likely protect your financial opportunities – and your FICO scores.
This is something you need to consider before you opt to skip a mortgage payment or modify your mortgage payments.