As real-estate values dropped and the unemployment rate in the US soared, the Obama administration began introducing a stimulus program early this year that called the Making Homes Affordable program which is a so-called loan modifications in order to save the homes of millions of Americans. Through this program, lenders agree to adjust terms of the loan, lower the interest rate or extending the period of repayment. For borrowers who do not qualify for the stimulus program, mortgage companies provide their own programs.

However, it turns out now that homeowners are facing difficulties in modifying a loan because there are conflicting advice from mortgage companies, delayed or even lost paperwork and others. One of the worst difficulties that borrowers are now facing is that lenders apparently report these loan modifications to credit bureaus in ways that can actually hurt a good credit history.

Knowing this one may ask, why something like a stimulus program that is endorsed by the government itself would hurt your credit score. Apparently only shortly after the government launched its modification program, the Consumer Data Industry Association, which is a board representing credit bureaus, adviced lenders to classify modifications as “partial payment”. If a loan payment is classified as “partial payment”, it is considered comparable to a missed payment which hurts your credit score.

Fortunately, starting in November, lenders will be able to use a new code that specifies a mortgage that was modified under the government plan. The code will not exactly eliminate the hit to the credit files, but it will certainly reduce it. However, if the borrower modifies their mortgage loan with their own lender as opposed with the government through the stimulus program, they will still see a significant hit on the credit files.

How bad the credit score will be hit after modifying your mortgage loan under the government program really depends on what else is in your credit files. If your credit has already taken a beating, your score would probably not fall by much. But if your credit score is quite reputable, getting a modification on your mortgage could cause your score to drop steeply.

Borrowers who are opting for a loan modification by the government, will have their mortgage payments lowered to 31% of their gross monthly income. Before your modification is approved, you will have to go through the three-month trial period while paying the reduced amount. If you were behind on your payments prior to the trial period, lenders will keep reporting you as delinquent. This will hurt your score. After the trial period some lenders will continue to report the modification as “partial payment” – this too will hurt your score. However, even if you are current, lenders who are supposed to report you as current, may still report your modification as “partial payment”, which is also considered negative.

So what’s left for homeowners to do? Should you just leave it and simply go through a foreclosure? No. Foreclosures are even more damaging to your credit score and it will stay in your credit files for 7 years.

What you can do is to negotiate with your lender so that they report loan modifications and short sales in ways that are less damaging to your credit history. You can contact your real-estate broker or mortgage counselor and asked them to hep negotiate your loan modifications. Some brokers and counselors have some success in getting lenders to report short sales to the credit bureaus as “paid as agreed” which is less damaging. The most important thing to know is the language your lender is going to use to report your modification.

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