The guidelines for the Home Affordable Modification Program (HAMP) state that if you're current on your mortgage before entering into a trial loan modification and you make your modified payments on time, your lender is not supposed to report your payments as "late." So why are some trial modifications hurting the credit scores of borrowers who pay on time?
Many mortgage servicers have been reporting modified mortgage payments to the credit bureaus as "rolling 30-day late payments" while the borrower is in a loan modification trial period (generally the three months before a permanent modification is granted or the homeowner is told he or she doesn't qualify).
Homeowners may be considered by the lender to be "delinquent" during the trial period because the modified payment amount is not the payment agreed to in the borrower's original mortgage documents. Since there is no new agreement yet, the credit reporting system considers the homeowner in a trial modification to be making a partial payment and not paying as agreed -- and therefore delinquent each month. A 30-day late payment may be reported every single month until the modification has been made permanent. Some servicers have gone as far as telling their borrowers that they are required by the Treasury Department to report modified mortgages that way.
When HAMP Trials Should Not Cause a Late Payment
If you are current on your home loan when you start your trial loan modification, you should not be reported as late, according to HAMP administration guidelines. If you were behind on your mortgage payments when you started your trial period, however, your lender does get to report you as late during the trial period. Servicers are also allowed to include a comment code that indicates the borrower is in a loan modification program, which may have a negative effect on the credit score (depending on how the bureaus' scoring models treat it).
If your loan modification is not being done through HAMP, your lender can report your payments according to its own guidelines. However, you may be able to negotiate your credit reporting as part of any modification, deed-in-lieu or short sale agreement.
How Can You Avoid Credit Reporting Mistakes?
For many, it's not the credit reporting itself that is so upsetting. It's the fact that they are often not advised about these derogatory "trade lines" before entering a trial modification. One thing you should do is to get your servicer to inform you in writing exactly how your account will be reported during and after the trial modification period. Then, monitor your credit files. If you find the lender doesn't do it correctly, consult a housing counselor; he or she can inform your lender of what the guidelines are and where to find them. The second thing you can do is bring your account current, if you can, before starting your trial period.
Since HAMP is still a new program, it is too soon to accurately quantify how much a mortgage modification will affect borrowers' credit scores in general, and almost impossible to predict how it will affect the score of any specific individual.
If you foresee the need for credit in the near future and you are current on your mortgage, you might want to hold off on applying for a loan modification until you have borrowed the money you need. The same is true if you are applying for a new job or insurance; your credit score can affect your eligibility or influence how much you pay. WalletPop mentions one homeowner profiled by Bloomberg who saw his score dive 121 points after he was approved for a loan modification. This caused his business line of credit to be cut from $15,000 to $500.
If the downside of a credit score reduction exceeds the potential upside of a lower mortgage payment, leave your mortgage alone if you can afford to do so.
Credit Score Drop: Unfair to Borrowers?
According to the Associated Press, the Consumer Data Industry Association -- which represents credit bureaus -- says they wouldn't be doing their job if a request for mortgage help didn't trigger some kind of warning shot for potential creditors. Often, an application for a mortgage modification is just the first sign that a borrower is in financial trouble, and credit scores are supposed to differentiate between the fiscally healthy and the troubled. Often, "The consumer is going into the program because they're in a financial bind," explains spokesman Norm Magnuson. "Other lenders would need to be aware of that."
In the end, homeowners experiencing true hardship will probably not let the potential for credit score reductions keep them from applying for loan modifications, especially considering that your credit score is treated far more negatively by a foreclosure than any modification effort.
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Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte.