Fed’s mortgage modification program: Keep your house, lose your credit

Americans who choose to take advantage of the government’s Home Affordable Modification Program as it stands today are entering into a buyer-beware system that may deliver short-term relief but also long-term pain. Although the program, known as HAMP, works to reduce monthly mortgage payments by half or one-third of monthly income, the program can also ruin participants’ credit for years to come, severely limiting their ability to borrow money and threatening for that reason to extend the housing crisis at the heart of the recession.

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The Department of the Treasury and the Department of Housing and Urban Development have reported that the program modified 116,000 loans in February, almost doubling the number modified in January.

HAMP borrowers, though, may be startled to┬álearn that enrolling in the plan might cut their credit score by 100 to 150 points, a major deal for anyone looking to make future investments. But that credit jolt isn’t supposed to be part of the program, necessarily, and seems to be a matter of bureaucratic oversight in planning and mere logistics in day-today operation of the program.

Assistant Secretary for Housing and Housing and Urban Development department Commissioner David Stevens told the Colorado Independent that the government had yet to develop a policy to deal with the problem and he acknowledged that sinking a good portion of citizen credit might work against the thrust of the program, which is to shore up borrowing as a way to strengthen the economy more generally.

“There’s no question coming out of this recession that there is a segment of borrowers who went through significant stress at no fault of their own and who are ultimately re-performing, have gotten themselves into a position to buy a home… The question is What will [participation in HAMP] do to that pool?

“We’ve talked to FICO [Fair Isaac, the nation’s top credit ranking firm] and FICO said that even with the impact of a late mortgage, borrowers might still retain credit scores well above what is needed for a new mortgage…. We have no policy in place at the administration level but it is something that we are looking at.”

In fact, exactly what will happen to the credit scores of the hundreds of thousands of people participating in the program is uncertain and may depend not on the working of any overarching policy but the attentiveness of individual borrowers and bankers.

“We know now that this is an issue that needs to be looked at. We haven’t directed how the credit should be treated because it’s the [loan] servicers who will report credit. They’ll report it the way they’ll report it.

Details are being worked out variously on the ground in banking offices all around the country.

Bank mortgage adjusters explain to HAMP borrowers that their adjusted monthly payment must be paid on time three months in a row and then officially becomes the new payment. For those first three months, however, your payments are recorded as “partial payments” and that will dock credit scores by an average of 100 points, a fact most borrowers may find surprising, even though the application to the program states as much.

HAMP applications explain that, according to the Treasury Department, credit scores will drop 100 to 150 points but that completion of the program will also affect your score, presumably for the better.

Barry Paperno, consumer operations manager for myFICO, told the Colorado Independent that those credit dips only really hit people with good credit. “And it’s really only for those first three months,” he said, “in the best case scenario.” It’s up to individual bankers and borrowers to be vigilant about the paperwork, he said.

After the three-month trial period, borrowers are provided with a “CN” code that indicates they’ve had their mortgage adjusted. The “CN” code replaces a negative “AC” code that borrowers notch when they pay late or partial payments, as during the three-month HAMP trial period. Paperno said replacing the codes could save a credit score from damage.

But Paperno is quick to qualify. He said, for example, that if a borrower decides against entering the HAMP program for whatever reason after taking part in the three-month trial period, their score is unprotected by the special “CN” code.

Stevens said a significant number of HAMP participants fall out of the program but that extensions of the trial-period are available.

Paperno reiterated the point that at thios point, how lenders are reporting modified payments to credit bureaus varies, so it’s up to borrowers to double check lenders are doing the work correctly and attaching the propoer CN codes.

“This is all completely voluntary [for the lenders]. It’s up the lenders how they report these things,” Paperno said.

Meg Rielly, a Treasury Department spokesperson, told the Colorado Independent that the credit score modification was put in place to make sure credit reports “appropriately reflect the fact [HAMP participants] obtained a reduced payment from their lender.”

She said that Treasury worked with CDIA, an independent credit assessment firm, to develop the CN code to represent the credit risk posed by HAMP borrowers.

In fact, the true meaning of the new CN code is being constructed by now by HAMP borrowers. FICO is right now tracking the credit worthiness of CN-branded consumers.

“Fair Isaac reports this code will be neutral for at least a year after it’s implemented. This is because the impact of any credit reporting code is based on the historical behavior of other borrowers with that credit behavior. There is no performance history yet for HAMP borrowers so there is no way for Fair Isaac to quantify the impact on FICO scores,” Reilly wrote in an email.

“Getting a modification, even with this code, can have an effect on your credit score. Obviously, it will have the most minimal effect for those who stay current on their payments. And most important, it will have a far more preferable effect than foreclosure.”

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