Will a home loan modification affect my Credit Score?

If you want to stay in your own home and avoid foreclosure, then you should consider a home loan modification. Are you worried what impact will this home loan modification will have on your credit score, and is it a good idea or a bad one to resort to this new idea?

Well, most of the homeowners do share your fear or worry. No single answer can be given for your questions. The impact on your credit score will depend on the amount not paid by you and the revised terms of the mortgage loan modification.

Your credit score should not get affected by a home loan modification, because, in technical terms, no money is borrowed from the lender. If the liability or debt burden is relatively small, then naturally the interest payments towards that debt will be less. As part of home loan modification, most lenders prefer to revise the interest rate downwards, and there is every possibility that your credit score will not be affected, but improve, as the monthly payment will be less.

Ideal Scenario

Though not quite common, some lenders even consider writing off a part of the principal amount in a home loan modification. If your lender decides to write off $50,000 from your principal, the loan reflected in your credit report will accordingly get reduced, and as such your credit score might improve as payment towards liabilities will be lesser.

Role of the lenderThe impact on your credit score also depends on the lender. The lenders need to report the details of a home loan modification to the credit bureau, and invariably the lenders state that the original amount owed is less than the amount sanctioned under a home loan modification. Since you settle for an amount different from the actual amount owed, your credit score might be affected negatively. In case you have given notice for foreclosure or in it already, then your credit score will further get affected. In any case, a home loan modification is a much better option in comparison with a short sale or a foreclosure, as the probability of maintaining a better credit score is more in a home loan modification.

Incidence of TaxEarlier, a loan modification is deemed as taxable income, equivalent to the amount forgiven, by the IRS authorities. If, by way of loan modification, your total debt burden is reduced by $50,000, IRS considers that waiver as income and corresponding tax becomes payable. Many of the homeowners resorting to a home loan modification are not aware of the tax implication at the time of entering in to a revised contract, and as such, they might be in trouble during the tax season.

In a ruling, the IRS made it clear in 2007 that loan modifications will not be treated as “prohibitory transactions”. IRS also stated that ruling applied to all such mortgage loans that were contracted when the sub-prime boom was at its peak between January 2004 and June 2007, and to those loans that were due for adjustment beginning from January 2009 to June 2012. In case, your mortgage loans fall either into the first category or to the second category, then there is no need for filing a declaration 1099 stating the change as “taxable”.