Navigating Loan Modification Options for Personal Loans

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ByChristopher Boston
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Reviewed byAlvin Yam, CFP
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Updated: February 28, 2024

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According to TransUnion, Americans owed $241 billion in personal loan debt in the third quarter of 2023. While personal loans offer quick access to funds for various purposes, managing them can become challenging, especially when unexpected changes in financial circumstances occur.

In these situations, a loan modification can be a lifeline. However, while it can provide immediate relief by lowering your monthly payments, it's important to consider its benefits and potential long-term impacts on your financial health and credit score. Carefully weighing these factors is critical to making an informed decision that supports your financial stability.

What Is Loan Modification?

Loan modification is a process where the terms of a loan are adjusted to make repayment more manageable for the borrower. The primary purpose is to provide relief to those struggling to keep up with their loan payments due to changes in their financial situation. Essentially, loan modification is designed to help borrowers avoid defaulting on their loans, ensuring they can meet their financial obligations without excessive stress.

Considering loan modification can be a strategic move for borrowers facing financial challenges. By reducing monthly payments, it provides much-needed breathing space for those struggling with their current repayment schedule. This adjustment helps avoid the negative consequences of missed or late payments on one's credit score. However, it's essential to be aware of the long-term implications.

For instance, extending the repayment period of a loan could result in higher overall interest costs. The process itself might also require time and extensive documentation. Ultimately, loan modification is beneficial for borrowers experiencing temporary financial setbacks, offering a way to keep their loan account in good standing while making the payments more manageable in light of their current financial situation.

Loan Modification for Personal Loans

Homeowners often use loan modifications for mortgage loans to help borrowers avoid foreclosure by changing the loan's terms. This has led to a general perception that this option is primarily, if not exclusively, for mortgage loans. However, the scope of loan modification extends beyond just mortgages.

In the case of personal loans, modification may be possible based on the lender's policies and the borrower's specific financial challenges. Suppose you're having trouble paying back a personal loan because of financial challenges like a drop in income or unexpected expenses. In that case, you may want to approach your lender to discuss modifying your loan.

Communicating openly and proactively with your lender to explore the possibility of restructuring your loan terms will help make repayment more manageable in light of your evolving financial situation.

Options for Loan Modification

Loan modification for personal loans involves adjusting the terms of the loan to make repayment more manageable for the borrower. These modifications can vary in approach, with each one tailored to address specific financial challenges.

Extending the Loan Term

Extending the loan term involves lengthening the period you will repay the loan. Doing so decreases the amount you need to pay each month, making it easier for borrowers to manage their monthly financial obligations.

This can be a crucial adjustment for individuals experiencing temporary financial setbacks, such as decreased income or unexpected expenses. Lower monthly payments can free up cash for other necessary expenses, helping to stabilize your financial situation.

It’s helpful to consider the long-term implications of extending the loan term. While monthly payments become more manageable, the total interest paid over the life of the loan typically increases. This is because the borrower is paying interest over a longer period. As a result, the overall cost of the loan can be higher than it would have been with the original terms.

Reducing the Interest Rate

Reducing the interest rate on a personal loan can significantly alleviate the financial load for borrowers. This involves negotiating with the lender for a lower rate, effectively decreasing the overall cost of borrowing. With a reduced interest rate, each monthly payment will have a larger portion going toward the principal rather than the interest, potentially accelerating the payoff timeline and reducing the total interest paid over the life of the loan. Reducing the interest rate can also positively impact your debt-to-income ratio (DTI) by lowering payments and interest costs and freeing up monthly cash flow.

Note that not all lenders may accommodate a request to lower the interest rate. The lender's policies and the specific details of the borrower's situation play a significant role in determining if a rate reduction is possible. Preparing a compelling argument as to how a lower rate would be mutually beneficial is a crucial step in this negotiation process.

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A good payment history and a solid credit score are often key to successfully negotiating a lower interest rate. Lenders generally favor borrowers who have consistently met their payment obligations.

Forbearance and Deferment

Forbearance and deferment are especially useful for borrowers facing temporary financial hardships. Both options provide a pause or delay in loan payments, but they function slightly differently.

Forbearance on a personal loan allows the borrower to temporarily reduce or suspend payments due to job loss, medical emergencies or other unexpected financial difficulties. This provides immediate short-term relief for borrowers who are temporarily unable to make their usual loan payments. Forbearance periods typically last three to six months but may be extended if the financial hardship continues.

During a forbearance period, interest continues to accrue and is typically added to the total loan balance, not just the monthly payments. This means that the overall balance of the loan grows, which results in higher repayment over the life of the loan.

Deferment, on the other hand, is a temporary suspension of loan payments. It's similar to forbearance but is often used in specific circumstances, like returning to school or military service. In some cases, depending on the loan terms, interest may not accrue during the deferment period. This can help maintain the loan balance at its current level during the deferment period, preventing it from growing due to accumulating interest.

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Note that a loan deferment can have tax implications. If the interest is waived during the deferment period, the borrower is not required to pay this interest at all. In this case, the waived interest could be considered income and subject to income tax. — Alvin Yam, CFP®

Principal Reduction

Principal reduction involves the lender agreeing to lower the total amount that the borrower owes. This adjustment reduces the loan's principal balance, resulting in smaller monthly payments and potentially less interest paid throughout the loan. It's particularly relevant for borrowers facing severe financial challenges where other methods might not provide enough relief.

It's worth noting, however, that offering principal reduction on personal loans is not a common practice and is often viewed as a measure of last resort by lenders. It usually requires in-depth negotiation and a clear demonstration of the borrower's financial hardships. Lenders might consider this step if they believe receiving a reduced amount is preferable over trying to collect the total sum over time, especially if the borrower defaults on the loan.

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Borrowers exploring principal reduction should be aware of its potential impact on their credit score. This type of adjustment is typically reported as a "settlement with a creditor," which can negatively affect a person's credit history. A settlement notation could lower someone's credit score and remain on their reports for up to seven years.

When a Loan Modification Makes Sense

Loan modification for personal loans can be a strategic decision, particularly for borrowers facing changes in their financial landscape. While not always necessary, there are certain instances where modifying a personal loan can provide significant relief. These include:

  • Change in Income: If a borrower experiences a significant reduction in income, perhaps due to job loss or a decrease in business revenue, modifying a loan can be crucial. In such situations, the original repayment plan might no longer be feasible, and a modification can help align the loan terms with the new income level.
  • Unexpected Financial Hardship: Medical emergencies or unexpected major expenses can disrupt a borrower's financial stability. During these times, a loan modification can offer temporary relief, allowing the borrower to navigate the crisis without falling behind on loan payments. It provides breathing space to reorganize finances without the stress of unmanageable loan repayments.
  • Change in Financial Obligations: Sometimes, a borrower's financial obligations might increase unexpectedly, such as through new family responsibilities or unforeseen debts. In these cases, a loan modification can redistribute financial burdens more manageably. By adjusting loan terms, borrowers can accommodate new financial demands while continuing to pay down their personal loans.

Remember, loan modification is not just about easing immediate financial pressure but also about ensuring long-term financial health. It allows borrowers to stay on track with their debts in a way that accommodates their current financial situation, thereby avoiding the negative consequences of loan default.

MONEYGEEK EXPERT TIP

You can explore a loan modification before missing payments if you anticipate future difficulty. Just one missed payment can damage your credit score in the short term, so it's worthwhile to be proactive. — Alvin Yam, CFP®

Alternatives to Loan Modification

While loan modification can be a valuable tool for managing personal loans, it may not always be the best solution for every borrower's situation. We highlight some of the alternatives here:

  • Refinancing: Refinancing involves taking out a new loan to pay off the existing one, often with different terms or a lower interest rate. This is a good option if your credit score has improved since taking out the original loan or if interest rates have dropped. Refinancing can lead to lower monthly payments or a shorter loan term, ultimately saving money over time. However, the new lender may charge upfront or closing costs similar to obtaining a new loan, so borrowers should evaluate whether the long-term interest savings of refinancing will outweigh any initial fees.
  • Debt Consolidation: Debt consolidation involves combining multiple debts into a single loan, typically with a lower interest rate. It's beneficial if you're managing multiple debt payments and want to simplify your finances. Consolidating debts can result in lower overall monthly payments and a more organized approach to paying off debt.
  • Personal Savings Plan: Creating a personal savings plan can sometimes be a more practical alternative to modifying a loan. If you anticipate temporary financial challenges, building up savings in advance can provide a cushion to continue making loan payments without needing a modification. This option requires proactive financial planning but can offer more control over your financial situation without altering loan terms.

Consider all of your options for managing loans to ensure that you make an informed decision that aligns with your financial needs and goals.

FAQ About Personal Loan Modification

It’s common to have questions about how personal loan modification works and when it's the right choice. To help clarify, MoneyGeek compiled a list of frequently asked questions below.

Not all personal loans can be modified. It depends on the lender's policies and the specific terms of your loan. Contact your lender directly to discuss if a loan modification is an option for your loan.

Typically, extending the loan term reduces your monthly payments but increases the total amount of interest paid over the life of the loan. This can make immediate payments more manageable, but the loan will cost more in the long run.

Yes, some lenders may allow you to negotiate a lower interest rate on your personal loan. This usually requires a good credit history and may depend on your lender's policies and your financial circumstances.

To apply for a loan modification, contact your lender to discuss your financial situation and request a modification. You may also need to provide financial documents and demonstrate a need for modification.

Loan modification can affect your credit score, but the impact is generally less negative than missing payments or defaulting on the loan. Some lenders may report the modification to credit bureaus, which can have varying effects on your score.

Potential drawbacks include a longer time to pay off the loan, increased total interest costs and possible impacts on your credit score. It’s helpful to weigh these against the immediate financial relief the modification may provide.

Some lenders may charge fees for loan modification, but this varies by lender and loan type. It's important to ask your lender about any potential fees before agreeing to a modification.

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About Christopher Boston


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Christopher (Croix) Boston was the Head of Loans content at MoneyGeek, with over five years of experience researching higher education, mortgage and personal loans.

Boston has a bachelor's degree from the Seattle Pacific University. They pride themselves in using their skills and experience to create quality content that helps people save and spend efficiently.


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The content on this page is accurate as of the posting/last updated date; however, some of the rates mentioned may have changed. We recommend visiting the lender's website for the most up-to-date information available.

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