How a Loan Modification Can Affect Your Credit

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If you’re pursuing a modification on your mortgage payments, you’re likely experiencing some financial difficulty. While a loan modification can make your payments more affordable, restructuring your debt can impact your credit in good and bad ways.

Here’s what you should know.

How a Loan Modification Can Hurt Your Credit

A loan modification often involves extending loan repayment terms, reducing your interest rate or balance, or putting your loan in forbearance. Lenders offer loan modifications to make payments more affordable and help stave off the possibility of foreclosure, which hurts you and the lender.

Technically, a loan modification should not negatively impact your credit score. That’s because you and the lender have agreed to new terms for paying off your loan, so if you continue to meet those terms, there shouldn’t be anything negative to report.

In many cases, modifications are only available to borrowers who have missed at least one payment or are nearing default on their mortgage. If you’re still current, your credit could take a big hit when you miss just one payment.

Depending on how the lender reports the modification to your original agreement and what is required before you qualify for modification, it could negatively impact your credit scores.

Because you’re changing the terms of your loan, a lender may report your modification to Experian, TransUnion, and Equifax as a settlement. That can have a huge impact on your credit and stay on your reports for several years.

What About Refinancing?

Similarly, if you refinance your mortgage at a lower rate to reduce your monthly payments, you shouldn’t have any negative credit impacts. Refinancing your mortgage is paying off your existing mortgage by taking out a new one, so there’s nothing negative to report.

In fact, you’ll need good credit to refinance your mortgage in the first place.

A refinance might damage your credit if you do a short refinance. Your home has lost value in this situation, and the lender agrees to write down the principal and issue you a new loan.

You’re basically doing a short sale to yourself. Unfortunately, it will show up on your credit score as a debt write-off for the next seven years.

A loan modification will likely impact your credit more than refinancing your mortgage. A loan modification changes the terms of your existing mortgage, while a refinance is simply obtaining a new mortgage on better terms.

A refinance should not have a negative impact on your credit other than possibly a small, short-term effect due to taking out a new loan and having your credit report pulled during the loan process. 

Same Loan vs. New Loan

Another possible issue is whether the lender reports the modification as changes to your existing loan or as closure of the old loan and opening a new one. The routine activity associated with replacing an old account with a new one generally doesn’t negatively impact credit scores. 

The modified mortgage would be newer than the original mortgage, which will shorten your active credit history. The length of your credit history accounts for 15 percent of the credit score calculation, so there will be some potential impact, but not an overwhelming burden to bear.

How a Loan Modification Can Help Your Credit

If you’ve missed one or more mortgage loan payments, your credit score has probably already been impacted. While a reported settlement can make things worse in the short term, that blemish will fall off your report seven years after the first missed payment.

While that’s less than ideal, it still beats foreclosure, bankruptcy, or several late payments before you attempt a modification. 

Foreclosure means you’ve defaulted on your loan agreement. In addition to a huge impact on your credit score, you’ll be sidelined from buying another home for anywhere from two to seven years, depending on the type of loan you want.

A modification will take a while to fall off your credit reports, but this impact diminishes over time, especially if you take steps to rebuild your financial situation by paying bills on time. A loan modification can also make it easier for you to keep current with your other debt obligations, which also contributes to easing the impacts of bad credit on your record.

Some lenders may not report a change as a settlement, so your credit is unaffected. In fact, your credit score could improve because your monthly payment would be reported as decreased.

When negotiating a loan modification, ask your lender how they report it. They may even agree not to report it as an adjustment, particularly if you’ve been a good customer.

Check Your Credit Report Often

A smart move is to check your credit report frequently. Ensure your lender reports your mortgage payments correctly, either as a forbearance or paying as agreed. You don’t want to see late payments if the lender has agreed not to do that.

If the information on your credit report needs to be corrected, you can dispute it with the credit bureau. Under the Fair Credit Reporting Act, the bureaus generally have 30-45 days to investigate a dispute and delete the information from your file unless it’s confirmed.

Aaron Crowe

Aaron Crowe is a seasoned personal finance and real estate journalist. Aaron writes on real estate as it relates to mortgages, refinancing loans and lending for Refi.com.

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