Quick Answer: Trial loan modifications do hurt credit scores because lenders typically report modified payments as partial payment plans, which FICO considers serious delinquencies. Homeowners making trial modification payments are often unaware they’re being reported as immediately delinquent, creating a widespread misunderstanding about the credit impact.
Carolyn Said of the San Francisco Chronicle wrote an excellent article “Loan modifications often damage credit scores” that covers the reality of the damage that occurs to credit from a loan modification.
Here are some excerpts. You should read the full article for more information
“Struggling homeowners who get a loan modification to reduce their mortgage payments are often unaware that it can seriously ding their credit score. Moreover, if they don’t get long-term help, the temporary loan mod can bury them in a deeper hole of debt that increases the likelihood they’ll lose their home.
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Then, after 10 months, they got a letter from Chase saying they had been denied for permanent help and now owed $44,000 in past-due amounts and fees.
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“A lot of people don’t understand that by making the payments due on their temporary loan mod they’re reported as delinquent immediately,” said Margot Saunders of the National Consumer Law Center in Washington. “It’s a huge misunderstanding.”
“A lot of lenders are reporting these modifications as paying under a partial payment plan. FICO regards that status as a serious delinquency,” said Craig Watts, a spokesman for FICO, which writes the software the credit bureaus use to determine scores. “There’s one saving grace if the lender reports the modification as being under the auspices of HAMP, but that does not mean the lender won’t also report the loan as being a partial payment plan.”
Watts said it is a “widespread myth” that short sales and deeds in lieu of foreclosure have less impact on credit scores than do foreclosures.
“Forcing people to be late is standard,” said Maeve Elise Brown, executive director of Housing & Economic Rights Advocates in Oakland. “I have never talked to a (struggling) homeowner who hasn’t been told by the servicer that they cannot do anything for them unless they go delinquent.”
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I just spoke with my lender Wellls Fargo regarding partial payments and credit bureau reporting. The rep I spoke with indicated that there is no longer a negative impact to ones credit score due to new reporting methods.
Is this true – or was the rep mistaken?
It really comes down to how the mortgage company reports it.
Steve
Hello Steve. I wrote an article about this a few weeks back. Here is an excerpt that explains the reporting:
When the Making Home Affordable program was conceptualized, it lacked a reporting mechanism for lender to use when informing the credit reporting bureaus homeowners were participants. Without direction, lenders used an existing code, AC, which means “paying under a partial or modified payment plan.” The issue for these borrowers is that the AC code is used when customers had made only a partial payment.
Lending is a risk-based business founded on the accurate portrayal of consumers meeting his or her financial obligations. Therefore, providing notations regarding mortgage repayment is very important for lenders in determining if someone is a good candidate for financing. The challenge with using the existing AC code is those homeowners who were current on their mortgage experienced a drop in their credit scores simply for using the program. Indicating the homeowner has made a partial payment notation is considered negative mark, and can significantly reduce these individuals’ credit scores. In a recent interview, a Treasury Department spokeswoman estimated that scores could fall from 30 to 100 points because of the reporting, depending upon the additional information in the homeowner’s credit profile.
So, why did lenders use the old code — it was the closest fit. The Consumer Data Industry Association and the Treasury Department developed a new code, which took effect in November. The new CN code means “modified under a federal government plan” and currently has no effect on credit scores. However, this could change in the future should FICO conclude that those participating in the program represent a risk to the lending community.
FICO, formerly known as Fair Isaac Corporation, is the producer of the most widely used credit score formula by credit bureaus like Equifax, Experian and TransUnion. Credit scoring is important because it determines the possibility that the borrower may default on financial obligations. Essentially, it speaks to the risk borrowers represent. In order for this system to run efficiently, FICO continually reviews its data to determine what trends affect the validity of their scoring formula. Should their research indicate that modification recipients represent a higher risk to lenders, the CN code could still impact an individual’s credit score. At this point, all we can do is wait and see.
The Treasury Department has indicated that the AC code will eventually be corrected to reflect the CN code adopted in November. In the meantime, homeowners who participate in the government program can dispute the AC listing each of credit reporting agencies and request it be updated to reflect the new CN code.
Looks like we now need to get lenders to use the new code now that it has been created.
Thanks for the update.
Steve