Loan Modifications: What You Need to Know
A loan modification is one of those terms that is heard in the real estate industry, but for many is left without any real meaning until it is absolutely necessary to ask – and for some after that. This article will break down what a loan modification is, what a loan modification agreement includes and what exactly it means for the parties involved.
What is a Loan Modification?
A loan modification is a modification to an existing loan (or mortgage) that is created by the lender in response to a borrower’s long-term inability to repay the loan. Loan modifications typically involve one or all three of the following options: a reduction in the loan’s interest rate, an extension of the length of the term of the loan, or a different type of loan altogether. Depending on the situation, the lender in question might be open to modifying a loan because the cost of doing so is less than the cost of default.
What is a Loan Modification Agreement?
A loan modification agreement is the legal and binding document that lays out the new details and specifics of the loan modification. A loan modification agreement covers every facet of the newly modified loan, these aspects include but are not limited to: the money that is still outstanding, new payment terms and payment deadlines. By signing it, the borrower and the lender promise to follow the new terms and signify that you understand that you will face penalties if you don’t. Once the loan modification agreement is signed, your loan modification kicks in immediately and you can begin making payments under the new terms.
What Does a Loan Modification Agreement Include
Loan modification agreements can vary depending on the lender, and are often customized depending on the particulars of the borrower’s situation. However, there are several things that all loan modification agreements must include in one form or another. These include:
Current outstanding loan amount – how much you still owe the lender at the time the loan modification takes effect.
Maturity date – this indicates the date when the loan repayment period ends and the entire outstanding loan amount must be repaid.
New interest rate – the interest rate that you get as part of the loan modification. Usually, the lenders will lower the interest rate, though this isn’t always guaranteed. The agreement also indicates whether the interest is fixed or variable. If the interest rate is fixed, this number indicates your interest rate for the duration of the loan repayment period. If the interest rate is variable, the number indicates the starting interest rate. It will be adjusted according to market conditions after a certain period of time. The loan agreement should specify how long that period lasts.
Covenants – this covers all of the obligations between the lender and the borrower. It the part of the document that states that you agree to repay the loan under the terms specified above or face penalties from the lender. It also specifies what those penalties and what conditions are necessary to trigger those penalties. This is also the part that ensures that lender doesn’t change the terms of the contract on a whim.