Last hurricane season, the FHA, USDA, VA, Fannie Mae, and Freddie Mac each offered mortgage relief assistance to respective homeowners affected by Hurricanes Harvey, Irma, Jose, and Maria. These moratoriums on foreclosures include loan forbearance and modification, helping borrowers buy time as they focus to rebuild their lives after the disaster.
To be clear, the two options are standard mortgage solutions available to homeowners offered by private lenders or through government programs. What’s the difference between loan forbearance and modification?
What Is Loan Modification?
It involves changing certain aspects of your loan. These changes are permanent and meant to help you afford your loan in the long run.
You need to obtain your lender’s consent to change any term of your loan. The lender agrees to do the modification as a loss mitigation.
Examples of loan modification as set forth in this FHFA report are:
- Reduce the mortgage interest rate
- Extend the loan term
- Reduce the rate and extend the term
- Reduce the rate, extend the term and forbear the principal
Converting an adjustable-rate mortgage to a fixed-rate mortgage is also another way to modify a loan.
To qualify for this loan modification, you must show financial hardship such that you are unable to make the regular monthly payment. You must also prove that you are capable of paying the new monthly payment during a trial period.
Then, you will be asked to submit documents pertaining to your request and financial circumstances.
What Is Forbearance, Then?
Forbearance is when the lender agrees to forbear or reduce your principal loan balance.
As noted above, forbearance is another form of loan modification but it has two distinguishable characteristics:
- It is a short-term solution. The lender agrees not to initiate any foreclosure action for a certain period of time or the forbearance period. At the end of this period, the borrower is typically asked to resume making payments on the mortgage and any other amount that can bring the mortgage back to being current.
- It is to remedy a temporary hardship, although the lender can extend the forbearance period while the hardship remains unresolved.
It’s different from a repayment arrangement where the lender spreads the total amount of your missed payments over a period of time.
Loan Modification vs Refinance
Given that a loan modification involves changing certain terms of your loan, doesn’t it sound like a refinance?
A refinance is basically a new loan, thus the new rate and term and cash-out to some extent. To get this new loan, you have to qualify using your credit score, income, and home equity, among other things.
Some homeowners, on top of their financial hardship, might not be able to refinance because of being underwater, e.g. when their current mortgage debt exceeds the value of their home.
Loan modifications can help borrowers facing financial distress and unable to qualify for a refinance.
In certain situations where your loan is current and is owned by Fannie Mae/Freddie Mac, you could be eligible for the government’s HARP®. Under HARP®, you can get a new loan with a lower rate or a shorter term with a streamlined process.
HARP® expires in 2018 to be followed by newer streamlined refinance options from Fannie Mae and Freddie Mac.
The ultimate goal of either loan modification or forbearance is for the homeowner to avoid losing his/her home to foreclosure. Each option provides a permanent/temporary relief from the consequences of falling behind in mortgage payments.