What is a Mortgage Loan Modification?
The first mortgage loan modification law was created after the Great Depression to help keep struggling families in their homes. When the recent U.S. housing marketing bubble began to burst, the concept started gaining attention again.
The concept of a loan modification is actually quite simple: negotiating a modification to your mortgage loan so that you will not be forced into a short sale or foreclosure. It's a win for banks because they avoid having to resell a foreclosed property, and it's a win for consumers because they get to stay in their homes.
Although modifications to a loan will vary depending on a homeowner's current financial situation, the list below includes the most common types of modifications that can be made:
o Reduction in interest, or a change from a floating to a fixed rate
o Reduction in principal amount
o Reduction in late fees and penalties
o Lengthening of the loan term
The Mortgage Debt Relief Act
Before 2007, all forgiven mortgage debt was considered taxable income. Therefore, if, as part of your loan modification, your lender agreed to reduce your principal amount (e.g. by $20,000), then you would have been required to claim that as income on your tax return. However, as loan modifications and foreclosures began to increase significantly, Congress passed the Mortgage Debt Relief Act (MDRA) in 2007, which excludes forgiven mortgage debt on a taxpayer's principal residence as taxable income.
Forgiven debt can only be excluded from your taxable income if the home is your principal residence. As such, if you obtain a loan modification for a rental property or summer home, the forgiven debt will be considered taxable income for IRS purposes unless the taxpayer qualifies for the "insolvency" exclusion or if it is discharged through bankruptcy.
Home Affordable Modification Program
Another big change in the loan modification industry to be aware of is the new federally enforced Home Affordable Modification Program (HAMP). The program, which took affect in 2009, offers incentives to mortgage companies to help homeowners stay in their homes. Because of this new program, the demand for loan modifications has increased tenfold, which has unfortunately slowed down the loan modification process for many struggling homeowners. If you are hoping to modify the terms of your loan, be patient as it may take a few months to complete the process.
If you are approved for a loan modification, which involves forgiven debt, then you may still receive an IRS Form 1099 at the end of the year. The total amount of the debt that was forgiven will be listed in box 2. However, do not be concerned just because you receive this form as it does not mean you will necessarily have to include the amount in your total income.
If you receive a Form 1099, then you may need to file a Form 982 to seek exemption from your loan relief debts. To fill out Form 982, you will need to list the amount of debt that was forgiven, which you can find on your Form 1099. You will need to file your Form 982 with your tax return.