Loan Modifications Affect Consumer Credit Scores

July 25, 2010

Many consumers feel like they have been victimized by the banks as a result of their risky behavior in the subprime mortgage market. With the collapse of the housing market and the connected fall in house prices, coupled with job cutbacks and unemployment, many consumers were relieved to discover they could get help avoiding foreclosure through the government backed home loan modification program.

What consumers did realize though is that requesting a mortgage modification, even if not in foreclosure, could negatively impact credit ratings. This has angered consumers trying to do the right thing and discovering they are penalized anyway for years to come. People in foreclosure are not surprised to find their credit rating lowered due to late payments. But even consumers who have not made any late payments are finding their credit scores lowered by asking for modifications to their current mortgages.

According to the logic of lenders and credit rating agencies, anyone asking for a modification is indicating they are having financial problems. The credit score can drop by as much as 100 points when a temporary mortgage modification agreement takes effect. It does not drop again when the temporary agreement becomes permanent. But consumers who apply for the loan modification program and are not approved will see more than 100 points drop off their credit score.

The drop in the credit score affects the ability to get credit for years. Housing counselors agree with consumers that the negative credit scoring is not fair. Homeowners were not told their credit ratings would be impacted before applying for the modifications. Consumer advocates believe consumers are being punished even though they are acting responsibly and trying to stave off mortgage defaults.

Lenders like to point out that the loss of credit points is much less under the modification program than it would be due to foreclosures. A foreclosure can cost 150 points or more, but that is really little consolation. Already feeling victimized by the banks, consumers now feel victimized by their own government.

Lenders believe that the credit point drop is justified because consumers asking for loan modifications are obviously in financial trouble. The lenders believe the lending market should be aware of the consumer’s true financial status. If the credit score was left unchanged, borrowers would still qualify for loans they cannot afford.

The Obama “Making Home Affordable” program has been an enormous disappointment. Meant to help a million homeowners, only 170,000 have actually found assistance as of February. Many of the applications are bogged down due to missing documentation and mortgage companies dragging the process down through delays. The Obama administration has tried to put pressure on lenders to speed up the process, but to date the efforts have been largely unsuccessful.

The discovery that credit scores can fall even when not in mortgage default was yet another blow to embattled consumers. The Treasury Department and the banks offer little advice other than to say that paying bills on time in the future will lead to higher credit scores.

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