Loan modifications may or may not affect your credit score. Generally it is believed that a loan modification will have a positive impact on a borrower’s credit score. In case, if the lender has reduced the principle amount of your loan, it will also help you in reducing your debts. Also, if you pay off your debts on time after the loan modification for the next 6 to 12 months, your credit rating will start improving.
However, after the loan modification, if you’re late on your payments or start making partial payments, your credit score will get negatively affected. In addition, the lender would report the principle reduction as "debt satisfied for less than the full amount". This will also have a negative impact on your credit score.
In certain cases, the lenders would not accept your loan modification request if you’re not delinquent on your mortgage payments. You may have to show that you are 30 days late on your payments. If the lender reports this 30 day late payment to the credit bureaus, your credit score can go down by few points.
President Obama's Making Home Affordable Mortgage Modification also has similar downsides. If you accept this plan, the lenders will report the modification to the credit bureaus which may sharply reduce your FICO score though you are current on your mortgage payments. In addition, it would lead to higher interest rates on credit cards. Moreover, your credit limit can also get reduced.
Most borrowers, however, are not concerned about the drop in their credit score. A loan modification would rather help them in saving quite a lot of money. The main concern here is that neither the banks nor the government is making sure that consumers are aware of the credit rating impacts of a loan modification.