If you cannot afford to make your monthly mortgage payments and cannot sell your home because your mortgage debt exceeds the property value, your lender may agree to a loan modification. Modifications come in many forms, including principal forgiveness. In most instances, you can sell your home after agreeing to a loan modification. However, you may have to repay the "forgiven" portion of your mortgage debt when you sell your home.
Home Affordable Modification Program
In response to the housing crisis that began in 2007, the federal government initiated several loan modification programs that include the Home Affordable Modification Program (HAMP). Under the plan, your lender may agree to a principal reduction if you are current on your mortgage but owe more than your home's current worth. When you enter HAMP, your lender modifies your loan on a three-month trial basis. If you make your payments on time during the trial period, the modification takes effect permanently. If you sell your home, you have to repay any portion of your debt that your lender "forgave." Mortgage servicers including Freddie Mac and Fannie Mae participate in HAMP.
Principal Reduction Alternative
You can apply for a modification under Principal Reduction Alternative (PRA) if a company other than Fannie Mae or Freddie Mac owns your mortgage. You must first apply to HAMP and make sure you remain in good standing by not falling more than 60 days behind on your loan payments during the HAMP trial period. If you remain in good standing, the principal reduction takes permanent effect after three years, and thereafter you do not have to repay the forgiven portion of the debt. You do have to repay the forgiven portion of the debt if you sell your home within three years of the modification.
If you fail to make your mortgage payments on time during a trial mortgage modification under HAMP, your lender must allow you to try to arrange a short sale on your home. This involves your lender letting you sell your home for less than the balance owed. You achieve the same end result as a loan modification, but your principal reduction occurs when you sell your home rather than prior to the sale. Additionally, you can attempt to enter into a short sale after agreeing to a loan modification even if you do not fall behind on your payments; however, your lender may not approve such a deal. In some states, a lender can sue you for the unpaid portion of your mortgage debt after a short sale has occurred.
Some lenders offer loan modifications on a case by case basis, and these modifications do not follow the guidelines laid out in HAMP or PRA. In some instances, lenders include clauses that require you to repay any principal forgiven if you sell your home within a certain number of years. You should review the details of a loan modification with a contract attorney licensed to work in your state before you enter into any permanent arrangements with your lender.