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Loan modification is a change to the terms and conditions of an existing loan agreement. Borrowers may request loan modifications if they are experiencing financial difficulties, and lenders may grant certain concessions to help accommodate borrowers facing economic hardship.A loan modification can reduce a borrower’s monthly payment if the lender agrees to reduce the interest rate or extend the term of the loan. Lenders can also forgive principal and past due interest under a modified loan agreement. Below we describe how loan modifications work.
How Do Loan Modifications Work?
The way loan modifications work is a borrower and lender agree to change the terms and conditions of an existing loan agreement. A lender has no obligation to make any loan modifications, but a lender may offer certain concessions if a borrower is facing economic hardship.Loan modifications can reduce a borrower’s monthly payment by giving the borrower a lower interest rate, a longer term of repayment, or both. Lenders in some cases may offer special concessions to cure a borrower’s default on personal loan obligations.Lenders could report a delinquent account as current to the credit reporting agencies. Lenders could also grant borrowers a deferment that extends the term of the loan without imposing late fees. In some cases lenders may forgive a portion of a borrower’s unpaid principal, which could have tax consequences if the lender forgave or canceled $600 of debt or more.
Reasons for a Loan Modification
Below we highlight common reasons for a loan modification:
Default on a Personal Loan
As mentioned earlier, lenders for a personal loan may offer concessions to cure a borrower’s default. If borrowers cannot afford their existing monthly payment but have the income to afford a lower payment, both parties in that case may agree to a loan modification to reduce the monthly payment.Lenders in some cases may prefer to cure a default with an amicable loan modification rather than suing delinquent borrowers for breach of contract. Loans for personal use can help you consolidate debt, but failing to repay a debt consolidation loan can lead to severe delinquency. A loan modification can cure defaults before they enter the severe stage of prolonged delinquency.
Hardship
A borrower experiencing financial hardship may contact their lender and ask for temporary or permanent relief. The lender and borrower in that case could agree to new terms and conditions under a loan modification that may reduce the borrower’s monthly payment.A borrower facing temporary hardship may request additional time to make a required payment. Lenders in that case could grant a deferment. A deferment is a postponement on required payments that can help borrowers avoid late fees and having their accounts reported to a credit bureau as delinquent.
Can You Get a Personal Loan Modified?
You can get a personal loan modified if your lender is willing to make some concessions. As mentioned earlier, a lender has no obligation to make any loan modifications but may offer certain concessions if a borrower is facing economic hardship.There are certain disadvantages and advantages of personal loans, including their potential for helping consumers build credit as a pro and their potential to carry high finance charges as a con. One of the modifications a lender may agree to is reducing the borrower’s interest rate.
How Often Do Loan Modifications Get Approved?
A lender may offer two loan modifications in a rolling 12-month period for borrowers facing financial hardship. Such modifications could consist of account deferments. A deferment by itself doesn’t reduce the monthly payment, but a deferment gives borrowers more time to make required payments without facing late fees.A deferment is the most basic loan modification a lender can offer to an existing loan agreement. Another loan modification lenders may consider is reducing the borrower’s interest rate. It’s common for loan modifications to get approved if a borrower is facing temporary hardship. This can happen any year, especially during recessions and global pandemics.
Loan Modification: Pros & Cons
Here are some pros and cons of loan modification:
Pros of loan modification
Cons of loan modification
Can provide temporary or permanent relief to borrowers facing financial hardship
Borrowers may face tax consequences if the modification included debt forgiveness
Can cure defaults and bring delinquent accounts into good standing
Your credit score could drop if lenders report your account to credit bureaus as settled
Loan Modification Pros
Let’s review loan modification pros:
Amicable Agreement
Loan modification is generally an amicable agreement between the borrower and lender. The modification can provide borrowers with instant relief and allows lenders to retain customers through thick and thin.
Faster Processing
Loan modification is similar to refinancing, but modifying the terms on your existing account may offer faster relief than refinancing. That’s because loan modification is simply changing the terms of your existing loan while refinancing involves more steps of replacing the original loan with a new account.
Default Cure
Delinquent borrowers can negotiate loan modifications to cure a default. Borrowers who default on a personal loan could face costly legal action and a severe negative impact to their credit scores for failing to make required payments. Loan modification can serve as a remedy that gives delinquent borrowers a second chance to move forward in good standing.
Loan Modification Cons
Let’s review loan modification cons:
Credit Score
Your credit score could drop if lenders report your modified loan account to credit bureaus as being settled for less than the amount you originally owed. A lower credit score can make it harder for you to qualify for new credit and better terms for you.
No Cash Out Option
Loan modification features no cash out option, but homeowners with an existing mortgage can apply for a cash-out refinance loan as an alternative to loan modification. Loan modification doesn’t take advantage of the available equity homeowners may have in their homes, while a cash-out refinance loan allows homeowners to trade equity for cash.
Tax Consequences
Lenders may offer debt forgiveness as part of a loan modification agreement that provides relief to delinquent borrowers, but the IRS may consider that taxable income. As mentioned earlier, borrowers may face tax consequences if the lender forgave or canceled $600 or more of the borrower’s outstanding loan debt.
Is a Loan Modification Bad for Your Credit?
Loan modification may be good for your credit if it prevents a default on your account. Failing to make a required loan payment may constitute a default, and nonpayment delinquencies of 30 days or more could severely damage your credit.Loan modification can also be bad for your credit if the modification forgives a portion of your debt. As mentioned above, your credit score could drop if lenders report your modified loan account to credit bureaus as being settled for less than what you owed.
The Takeaway
Financial hardship is not always predictable, but borrowing money on the best terms for you could be in your best interests. Borrowers in some cases may consider modifying the terms and conditions of their preexisting loan agreements if the financial responsibility becomes too difficult to bear.If you need financing, Lantern by SoFi can help you compare rates for personal loans. Just provide basic information about yourself and the loan you need, and Lantern can guide you in the process to apply for a personal loan with the lender of your choice. Check your rate today and see if you prequalify.
Frequently Asked Questions
Does a loan modification hurt you?
What qualifies for a loan modification?
What are the types of loan modifications?
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Photo credit: iStock/seb_ra
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About the Author
Sulaiman Abdur-Rahman
Sulaiman Abdur-Rahman writes about personal loans, auto loans, student loans, and other personal finance topics for Lantern. He’s the recipient of more than 10 journalism awards and currently serves as a New Jersey Society of Professional Journalists board member. An alumnus of the Philadelphia-based Temple University, Abdur-Rahman is a strong advocate of the First Amendment and freedom of speech.
