Loan Modification Secrets Uncovered

Peter G. Miller
OurBroker®

Want to save thousands of dollars when changing loan terms? "Modifying" a mortgage rather than "refinancing" can put big money in your pocket and eliminate complex and costly closing rituals.

With a loan "modification" you take the mortgage you now have and change the interest rate and payment requirements -- just like an ARM. And just like an ARM, a change in rates and payments does not result in the need for a new closing, legal fees, survey, appraisal, or taxes. In contrast, if you "refinance" a loan you'll be required to have a closing and forced to pay a variety of fees and taxes.

Last week's column discussing modifications resulted in many requests for additional information, so here goes:

Question: Can all loans be modified?

To modify a loan requires the agreement of both lender and borrower. Since a loan modification request typically results in less interest, many lenders -- if not most at this point -- have little incentive to just say "yes." However, as the concept of loan modifying becomes more widespread, lenders can be expected to increasingly approve modification requests.

Question: I borrowed $100,000 several years ago and would now like to increase the loan amount to $150,000. Can a loan modification work in this case?

When a loan is recorded there's typically a tax based on the mortgage amount. Thus if a loan is modified and the interest rate, monthly principal, and loan length are changed, there is no event to tax. But if the mortgage amount increases above the original principal, then a state government will likely see "new" financing and something to tax.

A second reason that loan amounts likely cannot be increased with a modification is this: Suppose a home has two loans, a first loan used to acquire the property and a second mortgage, perhaps a home equity loan. In this case, if the size of the first loan increases, the security of the second lender declines.

When a home is foreclosed all money is used to pay off the first loan holder. Any remaining money is used to settle the claims of the second lender, and then the third lender, and so on. If there is little or no money left over after the claims of the first lender have been satisfied, the other lenders lose.

If we increase the size of the first mortgage, we also unfairly increase the risk of any second or third lender.

Question: I can refinance with no closing costs so why should I look for a loan modification instead?

There is a difference between "no closing costs" and "no costs." In your situation, the lender is paying your closing expenses. The lender must get that money from somewhere, and that "somewhere" is your loan in the form of a somewhat higher rate than might otherwise be available, a larger loan amount, a prepayment penalty if you quickly refinance, and perhaps all three.

Question: My lender will allow me to modify my loan, but only if I get a new appraisal. Why should I pay this cost?

Because it's not unreasonable, it's cheaper than refinancing, and it assures the lender that the property has sufficient value to justify continuing the loan.

Question: If a borrower can ask for less interest when rates go down, why can't lenders ask for more interest when rates go up?

They can -- and you can say "no."

The goal of the lender is to make more loans and generate more income. The goal of the borrower is to have less debt with less cost.

The reason for a lender to accept a loan modification request is to continue the loan and the stream of interest and servicing revenue it represents. If a modification request is not accepted, perhaps you'll refinance elsewhere.

Borrowers have different motivations, and since a fixed-rate loan agreement is in place and favorable to them in a rising market, consumers have no incentive to accept higher rates -- unless a lender would like to make some concessions.

Question: Other than money, why do lenders prefer "refinancing" rather than a loan modification?

Replacing an existing loan with a new mortgage can substantially impact lender risk. For example, if you live in California and buy a home with a new loan, your financing is generally considered a "purchase money mortgage." If you're foreclosed or go bankrupt, the lender gets back the house but cannot sue you for any shortfall. However, if you "refinance" you no longer have a "purchase money mortgage" and a lender can seek a deficiency judgment if you're foreclosed.

Question: I have a lender who will agree to a mortgage modification. Do I just write them a letter to create the new terms?

You want your attorney to review any proposed loan changes before signing anything.

Question: Are loan modifications a new concept?

The The Common-Sense Mortgage (HaperPerennial) in 1994 and in later editions discussed the concept in detail -- and surely there were other sources which earlier described loan modifications

Question Of The Week

Q I am an assistant with a real estate company but do not have a sales license yet. I sometimes recommend the company to buyers and sellers, but when the company assists them in buying or selling a home, I do not receive any extra compensation. This seems unfair. Should I not get a piece of the commission?

A No.

The broker cannot pay a commission because you do not have a real estate sales license. This is not up to the broker -- in many states, if not all, the payment of a commission to an unlicensed individual is generally prohibited.

As an assistant you are in a position to learn how the brokerage business works. The next step is to get a sales license so that you can profit from your connections. Your broker, the local real estate association, and the real estate regulatory agency in your state can all explain what's required to obtain a license.

Weekly Resource

Wonder where politicians get their money? Public Disclosure tells all, no doubt much to the discomfort of many in Washington.

Published: May 18, 1999

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Editor's Note: This article reflects the opinions of Peter G. Miller only and not necessarily the views of this or any other publication, organization or Website owner.