If You Care About FICO Scores, Don't do Loan Modification

With all the talk about the “Making Home Affordable” program, and with all the layoffs and pay cuts that Americans are facing today, it’s tempting to ask for a loan modification even if you are able, somehow, to meet your mortgage payment.

Before you decide to make that move, decide whether you’re going to need high credit scores in the near future.

Under reporting guidelines set forth by the credit bureaus and the Consumer Data Industry Association, your loan modification will be reported as a “Partial Payment Plan.” Under the FICO scoring method, that designation will lower your credit scores, even if you have never missed a payment.

Consumer advocates argue that this designation is an unfair penalty imposed on consumers. The lender has not reduced the principal balance, nor has it reduced the interest rate permanently. Loan modification is merely a temporary interest rate reduction – no different from a promotional or temporary rate offered by a credit card issuer.

For now, however, the reporting designation will stand.

Because loan modification is a relatively new solution to excess debt, FICO doesn’t have sufficient information to determine whether it should or should not reduce scores. Right now they simply don’t know if a person who seeks loan modification is a higher credit risk than anyone else.

Those in favor of the designation insist that loan modification is nothing more than a band aid. They say consumers are merely postponing the inevitable and that those loans will be in default within 6 months.

Either side could be correct, but only time and information gathering will reveal the truth.

Thus, if you feel that you’ll need high scores within the next couple of years, it would be best to struggle along with your current payment. It is difficult to see those around you getting a financial break while you keep on paying, but remember that they are simply paying with a different currency – their FICO scores.

Another option for homeowners who find themselves upside down in a mortgage but who want to keep their homes is to seek a short refinance. A short refinance is a refinance with the same lender, but with a portion of the principal balance forgiven.

This option will, of course, damage your credit scores even more
because it will be reported as a settlement or a charge off. But if you love your home and want to keep it, the trade off for lowered credit scores could be worth it.

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