How a Trial Loan Modification Affects Credit Scores

Loan modification – a process by which your mortgage lender changes the terms of your mortgage to lower your payments and help you avoid foreclosure – comes with risks to your credit scores. Struggling homeowners often don't realize that when they pursue a mortgage modification, they could be sacrificing their

good credit scores. For some people, credit damage is the very thing that makes foreclosure so scary. So its terribly sad and ironic when these people get a loan modification approved only to discover their credit has been trashed in the process. I'm going to tell you how to mitigate the damage loan modification does to your scores and come away from the process with your credit rating as intact as possible.

Qualifying for Loan Modification By Missing Payments

Although the government's official Home Affordable Modification Program (I never understood that whole “Making Home Affordable” or “Home Affordable Modification” business. The syntax there is just terrible. Has Uncle Sam ever heard of plurals?) does not require you to miss payments, your bank might.

Here's the rationale behind the “You have to miss payments or you can't get a loan modification” song and dance that so many lenders sing: They don't want to modify your home. Don't get me wrong, foreclosure is pricey and while most states allow lenders to sue you for those costs, that's just additional time and resources the lender has to put up. A loan modification reduces the bank's profits. So if you're still paying your mortgage – no matter how hard that mortgage payment makes it for you to get by each month – your lender figures you can continue making that payment. In the lender's eyes, if you're not missing payments, you're not hurting and thus don't need a mortgage modification.

Missed Mortgage Payments and Your Credit Score

Every time you miss a mortgage payment, even if you do it strategically just to qualify for a loan modification, your credit takes a hit. The worst part of this is that the better your credit is, the more missing mortgage payments hurts your score. For example, if you have a credit rating of 750 and you miss a mortgage payment, you could see your score drop 100 points overnight. Because the FICO scoring formula is a trade secret and the other entries on your credit report play a role in the points you gain and lose, there is no surefire way to know exactly how much a single payment hurts you. The bank, of course, could care less about your credit. The credit bureaus are the same. As a matter of fact, I read an article just yesterday on Experian's website claiming that the credit hit you take when strategically missing payments to qualify for modification doesn't matter because – get this – if you need a modification your credit must already be in the toilet anyway.

Ignorance. Plain and simple.

Loan Modification Reporting Codes Could Trash Your Credit Score

The reporting codes a lender uses when it reports information to the credit bureaus makes all the difference in situations such as these. When any creditor reports an account to the credit bureaus, it does so using a code. Once you enter a trial modification, your mortgage lender can report your modified loan in one of two ways: AC or CN. One is good. The other will gradually destroy your credit.

The CN and AC Trial Modification Reporting Codes

When the HAMP program was first put into practice, lenders had no way to notify the credit bureaus that the new, lower mortgage payments were the result of a loan modification trial period. Such things were

Payments too much? Modification can help.

uncommon, and the code for reporting them did not exist. So did lenders get together and rally for a new reporting code that was more accurate? No. They reported trial modification payments to the credit bureaus using the “AC” code. AC denotes partial payments. These consumers' payments were not, of course, partial. They were the new assigned payment. Because the modification was not permanent, however, these borrowers' credit scores suffered.

In 2010, a new reporting code, “CN,” was finally introduced that demonstrated partial payments as the result of a trial loan modification. The CN code has no immediate negative effect (although it may in the future, should FICO decide that consumers who are undergoing a trial modification present a greater financial risk to other creditors).

Verify How Your Bank Reports Your New Home Loan Modification

When it comes to credit, I've never been able to tell if loan officers lie through their teeth because they just don't care (or don't get a commission if they can't make things work out) or if they tell tall tales as a result of their own ignorance and inability to admit that they simply don't know the answer to some of your credit questions. So, here's your warning: Don't listen to anything a loan officer tells you about your credit. Ever. EVER. By all means, ask how different financial actions will impact your report, but never take the loan officer at his word. Always double-check on your own.

For this reason, you need to insist that your lender report your trial loan modification as “CN” and not “AC.” If you can push hard enough to get it in writing, do it. And always, always, always pull your own credit report afterward to make sure that your lender is keeping its word. The last thing you want to do is save your home only to throw away your good credit.

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