Will a loan modification lower your credit score?

Many people these days are considering if they should apply for the government sponsored loan modification program Making Home Affordable. One of the major concerns people have is what effect a loan modification will have on their credit score.

Until now a loan modification was reported in various ways depending upon the individual lender and their reporting policies. Some lenders would report a loan modification as “paid as agreed”, however, most would report them as “partial payment”, which has a negative impact on a person’s credit score.  A “partial payment” report is a serious derogatory, in the same category as a foreclosure or short sale according to FICO spokesman Craig Watts. Fair Isaac and Company, FICO, is one of the three largest credit reporting companies in the US.

New reporting plan

Starting November 1, 2009, lenders are encouraged to use a new benign way to report government-sponsored loan modifications. Under guidelines put out by the Consumer Data Industry Association, CDIA,  lenders should report them as a “loan modified under a federal government plan”.  CDIA is the association which represents credit bureaus. FICO, the leading provider of credit scores, will ignore this new notation for the time being. It will neither help nor hurt a person’s credit score until FICO decides how to treat it. FICO says new mortgage changes will not hurt scores. “Once there is enough documented performance for people who went through a government sponsored loan modification, we will be able to assess the accumulated data to determine how predictive it is”, says FICO spokesman Craig Watts. As a rule the analysts prefer having at least a year’s worth of performance data before making any changes to its credit-scoring formula.

Under the associations guidelines, if a person is current with his mortgage payments before and during a trial modification period (typically three months), the lender is supposed to report the mortgage as current.

Starting November 1, 2009, if the modification is approved after the trial period, the lender adds a comment that it was modified under a federal plan instead of the dreaded “partial payment”.

If the loan was at least 30 days past due before the trial modification, payments during the trial period will not bring it current. The lender will continue to report the appropriate level of delinquency, but if the modification is approved, it will reported as a modification under a federal plan.

Caveats

The new designation could hurt a borrower down the road if FICO decides to treat it as a risk factor. Even if it never enters the scoring formula, potential lenders can see it on an applicant’s credit report and decide for themselves how to treat it. Have in mind that in most cases the underwriter will look beyond a credit score and study someone’s full credit history when determining a borrower’s credit worthiness.

The new guidelines will not have an effect on people who have already modified a loan, although a lender could, at its discretion, apply them retroactively.

The new category was created at the behest of the U.S. Treasury Department.

The new reporting guidelines do not apply to loans that are refinanced or put into forbearance. These loans have their own separate reporting guidelines. These guidelines are for loans modified under government sponsored loan modification programs only.

First Choice Mortgage Company is committed to be an information and education resource for the Colorado mortgage consumer and a full range of mortgage tools can be found on our website  www.FirstChoiceMortgageCoLLC.com. We pride ourselves on being a full-service mortgage company where you get the advantage of experienced mortgage professionals, great rates and a very wide range of mortgage products.

First Choice Mortgage Company has built its reputation on providing outstanding service to its clients and the launch of www.FirstChoiceMortgageCoLLC.Com is yet another example of the company’s dedication to exceeding expectations.