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Loan Modifications Often Damage Credit Scores

Carolyn Said, SF Chronicle Staff Writer

Sunday, May 23, 2010

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.

That was the case for Victor and Patricia Mendez of Livermore. When demand began to slump for Victor Mendez’s tile contracting work, he and his wife asked their bank, JPMorgan Chase, for a loan mod.

“They said, ‘We can’t help you until you’re late,’ ” said Patricia Mendez. “It took a long time for me to get the guts to do that. I had never been late on anything in my life.”

The Livermore couple eventually did stop paying their mortgage, believing that was their best hope.

Chase denied that it had urged the Mendez family to become delinquent. In a statement, it said: “We have no policy to advise customers to stop making payments, and we can find no indication that we advised this customer to stop making payments.”

After several more months of calling and faxing in financial documents, the couple said Chase gave them a trial loan mod, temporarily reducing their payments.

Patricia Mendez said the couple made those trial payments for 10 months, while she took on a part-time job as a church secretary to improve their financial profile and Victor found extra work.

But at the same time, their credit rating steadily eroded as Chase first reported their missed payments and then recorded their trial payments as partial payments, she said. Credit card companies slashed their spending limits and raised their interest rates. The rate on one card jumped from 9 percent to 29 percent.

Devastating change

Because Victor Mendez’s work requires him to buy supplies, the poor credit was devastating. “To be a contractor without credit is nearly impossible,” Patricia Mendez said. “You have to buy job materials; you have to wait to get paid on jobs.” They had to juggle even more to come up with cash to buy work supplies, even cashing in an IRA.

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.

They have no hope of coming up with that amount, she said. The four-bedroom home where they live with their five children, ages 8 months to 19 years, was scheduled for a foreclosure auction later this month.

“We did everything (Chase) told us to and our credit was destroyed because of working with Chase,” Patricia said.

After being contacted by The Chronicle and by an attorney representing the Mendez family, Chase said it would review the loan for permanent modification because the family said it had increased income.

As for credit reporting, Chase spokesman Tom Kelly said: “We report to the credit bureaus when people don’t make their payment or their full required payment.”

The Mendezes’ experience points to some drawbacks of the Obama administration’s loan mod program. Trial loan modifications often hurt credit scores. Meanwhile, borrowers consistently say they are told they must be late on payments to qualify, which also hurts their credit.

“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.”

For borrowers who do end up getting long-term relief, the credit hits may be worthwhile, said Ruth Susswein, deputy director for national priorities at Consumer Action.

“If this is the only way to keep your home, then it may not matter,” she said. “But if keeping your home doesn’t work out, and (the process) makes your credit score even lower, you’re in a much worse place. This puts consumers in such a bind.”

Nearly half flunk

The administration’s most recent report on the Making Home Affordable Program shows that more than one-quarter million participants – 277,640 households – flunked out of the trial-mod program, meaning they will not get long-term help. Often those people are liable for all the past-due amounts accumulated during their trial mods, plus fees and penalties. Slightly more households – 299,092 – did get permanent modifications.

Industry officials say the whole point of credit reporting is to warn potential lenders about consumers who have had trouble meeting financial obligations – as is certainly the case for struggling homeowners.

“Accepting a loan modification can affect your credit score, but the actual effect will depend on a variety of factors,” warns a Treasury Department paper about the government Home Affordable Modification Plan, or HAMP.

In November, the administration came up with a new way for banks to report people enrolled in HAMP that is not supposed to ding their credit score – but in addition banks can still choose to report the payments as partial. And all the folks who were behind on their mortgage before they got help – including those who say their bank urged them to skip payments – are reported as delinquent.

“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.

“Generally speaking, when you can’t pay your mortgage, in the eyes of the FICO score what matters is that you were not able to fill your obligation as you originally agreed and that failure is highly predictive of future risk,” he said.

Most in default

The HAMP report says the overwhelming majority of those who got help – 77.1 percent – were in default, meaning 60 or more days late. The remainder were “at risk of default,” which it defines as including those up to 59 days delinquent or on the verge of default.

“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. Homeowners who call our office for advice regularly ask me, ‘Is it true I have to miss payments? Because that’s what my servicer told me to do before they would help me.’ ”

Modifying loans

If you’re requesting a loan modification, here are some steps you can take to try to protect your credit:

— Try to stay current on payments while requesting a trial modification.

— Try to get a loan mod under the federal Home Affordable Modification Plan (HAMP), which has less impact on credit.

— Request that the lender not report your trial loan payments as partial payments.

— Make your trial payments on time.

— Homeowners who believe that servicers are not treating them fairly or complying with program guidelines can contact the HOPE Hotline at (888) 995-4673.

E-mail Carolyn Said at csaid@sfchronicle.com .