Mortgage modification has been touted as the perfect solution for struggling homeowners, but experts have found a possible snag to the program: lower credit scores. There's no doubt that lenders report modifications to the credit bureaus, but borrowers happy enough to steer clear of foreclosure hardly give it a thought. Does a mortgage modification reflect negatively on your credit report? If it does, is it a good price to pay to avoid foreclosure?
How loan modifications are reported
Every transaction that gets reported falls under a classification code. A
mortgage modification is classified under a code called AC, which basically tells the bureaus that the borrower took part in the loan modification plan. The code was already in existence before the program was put in place, but was chosen because it was the closest match.
What it means
The problem lies in how the credit bureaus interpret the code. Basically, AC means that the borrower only made a partial payment, which equates to a minus in ones credit score. How much it affects the rating depends on other information in the borrower's file, but a representative from the Treasury Department said the drop can range from 30 to 100.
What's being done
When consumer groups brought the matter to attention, officials developed a new code in November that would protect people seeking mortgage modification from being unfairly judged on their credit reports. The new code, CN, will specify that the borrower obtained a mortgage modification under the government plan, and will not affect the credit rating.
However, it's still up to the lenders whether to use the new code or stick to the old AC. Since the AC code is associated with delinquencies, many banks may continue to use it for borrowers who were seriously delinquent at the time the mortgage modification was granted. The CN code may fit those who were current or only missed one or two months.
Risk factor
According to industry experts, a mortgage modification will always entail a negative mark, albeit much smaller than that of a foreclosure (which can slash up to 400 points off ones score). This is because the motivation for modifying a loan is financial distress, which by default makes one riskier even if he or she had never missed a payment before. The best thing to do is find ways to minimize the loss, such as paying as much of the debt as possible and choosing a mortgage modification plan with the least possible impact.
