Often used when you're behind on your payments and facing foreclosure, and when refinancing isn't an option, a loan modification changes your loan terms to make your monthly payments more affordable. But to qualify for this option, your loan servicer looks at a few expense-to-income ratios to determine if the payment gets reduced enough to meet the loan program's guidelines. Often, your housing expense and debt-to-income ratios will need to be close to the guidelines that the reduced payment places you within, but some programs offer more flexibility depending on your situation.
Overview of Loan Modification
The loan modification process involves working with your loan servicer to get a reduced interest rate, forbearance of unpaid principal or a longer term. The result is that your new payment may be reduced as much as 20 percent. Examples of these programs include Fannie Mae and Freddie Mac Flex Modification, the Federal Housing Administration – Home Affordable Modification Program, Veterans Affairs Affordable Modification and private programs through loan servicers.
In addition to helping you avoid foreclosure, obtaining a loan modification also does less damage to your credit than the alternative. Any delinquency you have with your mortgage gets put back on the principal balance so that you can start clean with affordable payments. However, the downsides are that you'll likely end up paying more interest in the long term and that the strict requirements to qualify mean it's not an option available to all delinquent borrowers.
Loan Modification Front-End Ratio
The first ratio loan servicers look at when considering you for a loan modification is the front-end ratio, also called the housing expense ratio. This refers to the percentage of your monthly gross income that you use toward paying your mortgage principal and interest, homeowners insurance fees, property taxes and possibly homeowners association fees. Depending on the loan program, loan servicers like to see that this ratio is a maximum of 28 to 31 percent.
To qualify for a loan modification, your front-end ratio beforehand may be higher than those limits, but the newly reduced monthly payment should put you within that 28 to 31 percent range. Otherwise, your loan servicer may consider that even a reduced payment would still be unaffordable for you and not qualify you for the loan modification. However, some loan servicers will accept a higher front-end ratio when you don't have many other debts.
Loan Modification Debt-to-Income Ratio
Perhaps the most important ratio your loan servicer will consider is your back-end ratio, or total debt-to-income ratio. This refers to the percentage of your gross monthly income that makes up your total debts, including housing expenses, car loans, credit card bills, student loans and other monthly obligations. Usually, a loan servicer prefers a maximum ratio of 36 to 50 percent, depending on the loan type and modification program.
Like with your front-end ratio, your debt-to-income ratio before modification may fall slightly over the limits, but your post-modification ratio will likely need to be within that 36 to 50 percent range for your loan servicer to approve you for the modification program. However, Nolo notes that certain circumstances and modification programs may give you more flexibility for your loan modification debt-to-income ratio.
Other Loan Modification Qualification Factors
Your loan servicer considers more than just your loan modification debt-to-income ratio and front-end ratio when deciding whether to approve you. For example, the loan in question usually has to be a first mortgage that you took out at least 12 months before the modification request, and you need to be able to prove a substantial hardship like becoming disabled, experiencing a natural disaster or losing your job. Loan servicers usually also look at how far behind you are on your mortgage payments, whether you're at immediate risk of foreclosure and if you had any previous modifications.
You'll need to back up your request with documents similar to those you submitted for your original mortgage preapproval, such as your tax returns, bank statements and proof of income. But you'll also need to present a hardship statement and other requested documents that show your current financial situation.
If you're approved, you'll usually have to complete a trial period where your loan servicer monitors whether you're able to pay your modified mortgage payment as required. After completing this trial successfully, you'll have a permanently modified mortgage.
- NOLO: What’s a Debt-to-Income (DTI) Ratio?
- Fannie Mae: D2-3.2-06: Fannie Mae Flex Modification (09/18/2018)
- Know Your Options by Fannie Mae: Modification
- U.S. Department of Housing and Urban Development: FHA-Home Affordable Modification Program (FHA-HAMP)
- VAMortgageCenter: Information on Modifying a VA Loan
- NerdWallet: Understanding Debt-to-Income Ratio for a Mortgage
- Justia: Flex Modification Program
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