A mortgage modification might hurt your credit rating

Like many people considering a mortgage modification, David L. of Oakland, Calif., wonders how it will affect his credit score.

Unlike most people in this situation, David has never missed credit payments and has a very high FICO score of 810. But when David, who works for the state of California, suffered a 15 percent pay cut as a result of the state’s three-day-per-month furlough program, he asked his mortgage lender to lower his payment under the government’s Home Affordable Modification Program.

“Four months into the process, they told me that if I were to start the modification process and they lowered my loan payments, my credit score would be negatively affected,” David said. “I am considering not proceeding with the modification because I am concerned about how it would affect my credit score. What they couldn’t tell me is how much it would affect my credit score. Would it be more like missing a payment or more like a short sale or foreclosure?”

Until Nov. 1, lenders reported mortgage modifications various ways. Some reported them as paid as agreed. But a lot were reporting them as partial payments, which have a negative impact on a person’s FICO score. “That is a serious derogatory, in the same category as a foreclosure or short sale,” said FICO spokesman Craig Watts.

Jasmine Bendon of Ventura, Calif., said her FICO scores dropped from the mid-700s to the low-600s after her lender put her on a trial modification and reported it as a partial payment. On the plus side, the trial modification has cut her monthly payment by $1,300.

As of Nov. 1, lenders have a new, more benign way to report government-sponsored loan modifications.

Under guidelines put out by the Consumer Data Industry Association, lenders should report them as a “loan modified under a federal government plan,” said Norm Magnuson, a spokesman for the association, which represents credit bureaus.

FICO — the leading provider of credit scores — will ignore this new notation for the time being. It will neither help nor hurt a person’s credit score until FICO decides how to treat it.

“Once there is enough documented performance for people who went through (a federal modification), we will be able to assess the accumulated data to determine how predictive it is,” said Watts. “The analysts prefer having at least a year’s worth of performance data” before making any changes to its credit-scoring formula.

Under the association’s guidelines, if a person is current with his mortgage payments before and during a trial modification period (typically three months), the lender is supposed to report it as current, Magnuson said.

If the modification is approved after the trial period, the lender adds a comment that it was modified under a federal plan instead of the dreaded “partial payment.”

If the loan was at least 30 days past due before the trial modification, payments during the trial period “will not bring it current,” Magnuson said. The lender “still reports the appropriate level of delinquency.” But if the modification is approved, it will be reported as modified under a federal plan.

The new designation could hurt a borrower down the road if FICO decides to treat it as a risk factor. But even if it never enters the scoring formula, potential lenders can see it on an applicant’s credit report and decide for themselves how to treat it.

“We have in the past looked beyond a credit score at someone’s full credit history and we will continue to do that,” said Tom Kelly, a spokesman for Chase.

The new guidelines won’t help people who have already modified a loan, although a lender could, at its discretion, apply them retroactively, Magnuson said.

The new reporting guidelines do not apply to loans that are refinanced or put into forbearance. They have their own, separate reporting guidelines. Nor do they apply to loans modified outside of government programs.

Should borrowers like David with good credit scores go ahead with modifications?

“First off, make sure it is a government-sponsored loan modification and not a home-grown one,” said John Ulzheimer, president of consumer education with Credit.com. “Also, ask the lender up front: ‘Will you continue to report me as current during the trial period?’ “

If the answer to both questions is yes, Ulzheimer would proceed with a modification, knowing it could dent your score if FICO ultimately treats it negatively.