The Fair Isaac Corporation provides credit scoring services through the FICO score. Most mortgage lenders rely on borrower FICO scores to determine creditworthiness. Conversely, poor performance on a mortgage account negatively affects FICO scores. A borrower's request for a loan modification impacts credit when the process involves missed payments and the lender negatively reports the event to the three major credit bureaus: Experian, TransUnion and Equifax.
The Basics
Loan modifications are an alternative to foreclosure that allow financially distressed borrowers to keep their home and repay all or part of the debt owed to the lender. Lenders generally handle the paperwork for loan modifications through a specific loss mitigation department. Because lenders often require borrowers to demonstrate financial hardship before accepting a loan modification, the lender may inadvertently encourage missed payments, says Bankrate.com. Because on-time payments are key to good credit, missing a payment to get a loan modified hurts FICO scores.
Considerations
Mortgage loan modifications take a toll on credit, says Bankrate. Because lender's departments do not always work together when a borrower is trying to modify, the foreclosure department may report missed payments, affecting borrower scores. Whether the default is strategic or unintentional, the borrower generally misses payments for the entire length of the loan modification process. The process typically takes one to three months, according to the National Association of Realtors. The length of time depends on how quickly the lender works, and how effectively the borrower navigates through the process. Complicated cases and insufficient documentation can slow the process.
Expert Insight
The lender chooses if and how they report a loan modification to the credit bureaus, according to MyFICO.com. Once the loan is modified, the lender may choose to report the event to the bureaus as an account not paid as agreed, which could damage the borrower's score. Whether or not and to what extent the negative reporting lowers the FICO depends on the borrower's credit prior to the loan modification. In general, a borrower with poor credit has less to lose than a borrower with excellent credit, in terms of points.
Considerations
A loan modifications' negative impact on credit scores diminishes over time. On-time payments also help reverse the effects as the borrower rebuilds their credit.
A negative reporting of a single account is less damaging than negative reports on several accounts. Requesting a modification of the primary loan can affect the status of junior mortgages, such as home equity lines of credit. Second liens may be extinguished or modified as part of a loan modification program, further impacting the borrower's credit.
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