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Loan modifications hurt credit scores

Some saw scores drop 100 points even though they never missed a payment.

By Teresa Mears Jan 6, 2010 3:15PM

People who lost income and are struggling to make mortgage payments thought they had come up with a way to save both their homes and their good credit scores: a mortgage modification.


But it turns out that a mortgage modification, even a temporary one, can hurt your credit score, sometimes as much as a foreclosure or short sale.


A story in the Detroit Free Press and a report on CNN Money told the stories of borrowers who hadn’t missed any payments and had applied for mortgage modifications after financial setbacks.

Jason Axelrod, who lives in the Chicago area, had a 750 credit score when he applied for a mortgage modification after he experienced a decline in pay and a big increase in property taxes. Chase gave him a temporary modification, reducing his monthly payment by $565, CNN Money reported.


But that payment reduction also brought a reduction in his credit score, to 644.

"It's completely destroyed my credit," said Axelrod. "If I had known it would affect my score, I would have never entered the program."


He had been paying 4.7% on a car loan, but the rate he was quoted to finance a new car, in light of his blemished credit, was 12%.


James and Carol Sperr, who live in the Detroit area, had a similar experience, Susan Tompor reported in the Detroit Free Press.


The Sperrs received a trial modification through Bank of America that cut their monthly payment, including taxes and insurance, from $1,140 to $957 a month.


Their credit scores, previously in the 800s, went down to 750, even though they didn’t miss any payments. The bank, however, reported them to the credit bureau as being behind on payments.


"They tell us that once the paperwork 'catches up' and the new loan is finalized, they will correct the credit reporting agencies," Carol Sperr told The Free Press.


One reason homeowners might seek a mortgage modification, particularly if they owe more than the home is worth, is to preserve their credit. Many have been surprised to see the same drop in credit scores they could expect from a foreclosure or a short sale, in which the bank agrees to let a homeowner sell the property for less than it is worth and cancel the remaining debt.


In contrast, the mortgage modifications cut monthly payments, but almost none of the workout deals reduce the total amount owed. The lower payment is usually the result of a cut in the interest rate or an extension in the length of the mortgage.


About 759,000 homeowners have received trial modifications, but only about 31,000 have received permanent modifications, with many complaining that going from a trial to a permanent modification requires sending the lender quantities of paperwork, often multiple times because it has been lost. The small number of modifications is one of many criticisms of the program.


Homeowners say they have received conflicting information on how participating in a mortgage modification would affect their credit scores. Many say they were told it would not hurt their scores, but lenders say they tell homeowners it could hurt their scores.

In the New York Times Bucks blog, Jennifer Saranow Schultz explains that part of the problem stems from the fact that lenders and credit bureaus initially had no code for modifications, so they used the code AC, which signifies partial payments. For someone with good credit, that could mean a drop of 30 to 100 points, a Treasury Department spokeswoman told The Times.


The Consumer Data Industry Association worked with the Treasury Department to create a new code, CN, which means “loan modified under a federal government plan.” That code went into effect in November.


“The Administration felt that it was important to ensure that homeowners who faced foreclosure weren’t unfairly punished for seeking a loan modification,” Meg Reilly, spokeswoman for the Treasury Department, told The Times.


But are we sure they won’t be? The long-term result depends on whether FICO decides later that  CN is or isn’t a predictor of bad credit behavior, Schultz noted.


The new code isn’t retroactive, meaning those customers who already have the AC code in their records may still suffer. If you have such a mark in your report, you should call your lender to request a change and then file disputes with the credit bureaus asking for a correction, Schultz advises.


Credit industry leaders believe receiving a mortgage modification should affect a homeowner’s credit score. “They are having financial difficulty, so there is some risk involved,” Norm Magnuson, spokesman for the Consumer Data Industry Association, told The Times.


What do you think? Should people be penalized in their credit reports for participating in the mortgage modification program, even if they never missed a payment and didn’t have any principal forgiven?


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