Loan Modifications Can Drop Your Credit Score by More Than 100 Points

Troubled homeowners are so worried about losing their home they will do anything to save it. This generally ends up including a loan modification. Loan modifications are a way of reducing monthly payments by a) reducing interest rates, b) extending the tenure of the loan, and c) in some rare cases even by reducing the principal balance of a mortgage.

However, many home owners are starting to realize that interest rates and mortgage payments are not the only things that are being lowered. The credit score of homeowners is being reduced by up to 100 points just for entering a loan modification program. 100 points in a scale that generally goes from 300 to 850 points is a significant blow to a homeowner that has taken good care to protect his credit rating.

The big question is: is it fair? Should it be done?

The main argument housing counselors are putting forward against this practice is the lack of transparency. Most of the times troubled homeowners that ask for a loan modification feel like they are doing the right thing by trying their best to pay for their mortgage despite financial problems. When they realize that there credit score has been hit despite their efforts the sometimes feel cheated.

Are they justified? It seems reasonable to me that lenders and mortgage servicers provide clear information on the consequences of taking on a loan modification. But would a troubled homeowner applying for a loan mod change his mind just because he realizes his credit will be affected? If they do, it probably means they did not really need it to start with.

Why should a loan modification affect your credit rating?

Credit scores and rating are in place to do one thing, help banks and lenders know how reliable a borrower you are. Reliability in this industry is proven by your credit history that is how good you have been at paying your debts, your income and your commitment to the security of the loan, in this case your home.

A credit score is a numeric value assigned to you that qualifies your credit history and how desirable you are as a lender. Now, let us try and detach the emotional aspect of being a troubled homeowner and think about the consequences of a loan modification. A loan modification will in the vast majority of cases mean a reduction in interest, principal balance, or both. This means the bank is losing money. Losing money the borrower agreed to pay. By applying for a loan modification the borrower is stating he or she is struggling to make the payments they agreed to make. Shouldn’t that affect their credit rating, their reliability as a borrower?

Even though applying for a modification will take a chunk from your credit rating it is probably going to shade into insignificance compared to the effect falling behind in your mortgage payments and God forbid, foreclosing on your home. These actions can leave your credit score in tatters for years, and fade into insignificance when compared with a 100 point hit.