With a loan modification, a lender will agree to modify the terms of a mortgage so that the borrower can afford to make monthly payments on her home. In the United States, loan modification commonly reduces the principle owed on a mortgage, extends the length of the loan or lowers interest rates on a home note so the homeowner will pay no more than 31 percent of her gross monthly income on her mortgage per month, according to Bank of America. Homeowners cannot always sell their house after a permanent modification without paying penalties.
While a short sale or foreclosure leaves a homeowner liable for the difference between principal owed and the sale price of the home, permanent loan modification binds a lender to certain terms over the duration of the mortgage, meaning that lender cannot a deficiency balance from a lender. Lenders will sometimes tack on an arrearage to a loan modification that legally binds the homeowner to pay her lender a lump sum of money when she pays off the loan after selling her property, according to The Law Office of Colby J. Leonard, LLC.
A homeowner cannot sell his home and take advantage of a modification until he completes the modification process, but he can sell immediately after the signing of a permanent modification agreement. Lenders will not generally restrict a homeowner’s ability to sell the property after a modification, because they receive federal funds for modifying loans and avoid the costs of foreclosure. Homeowner participation in government modification programs does not impact a homeowner’s ability to sell.
If a homeowner sells her property, she will agree at closing to transfer to her lender the amount she owes on her permanently modified mortgage from the proceeds of the home sale. If the homeowner sells the property for less than the value of the modified loan, she will owe a deficiency balance to the lender that the lender has the right to collect through the legal process. Homeowners should read the fine print in the modification agreement to ensure that a lending representative has not misled them into agreeing to a temporary modification, which also leaves them liable for a deficiency balance.
If loan modification adjusts a taxpayer’s cost basis in her home due to a lender’s agreement to reduce loan principal and she takes advantage of the Mortgage Forgiveness Debt Relief Act, she may increase the tax she owes on the sale. If a taxpayer accepts a modification, she lowers the cost basis in her home to the new principal plus improvements. If she sells the property, she will owe capital gains on the forgiven amount as profit. For example, a taxpayer whose bank reduces his home loan from $200,000 to $150,000 and who sells his home for $180,000 will owe capital gains on $30,000 unless he qualifies for a tax exclusion.
- IRS.gov: Home Foreclosure and Debt Cancellation
- The Law Office of Colby J. Leonard, LLC: Indiana Loan Modification Attorney
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- Bank of America: Home Affordable Modification
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Chris Hamilton has been a writer since 2005, specializing in business and legal topics. He contributes to various websites and holds a Bachelor of Science in biology from Virginia Tech.