Auto Loan Modification Explained

Auto loan modification is a broad term used to describe any change to your car loan contract. Most people who seek modification do so because they believe they can gain a more favorable contract the second time through than the first. Others can no longer afford their loan at the current agreement. In either case, modification is not an easy process, and it is not always possible.

Types of Modification

There are three primary types of auto loan modification: refinancing, settlement and consolidation. All three processes involve taking a wholly new loan in order to replace the existing contract. At times, this can be done through the original lender Typically, though, a new lender will take on the new loan.

  • Refinancing is attaining a similar loan at a lower interest rate or more favorable terms. For example, you may refinance a variable rate loan for a fixed rate loan.

  • Settlement is paying off the debt with one lump sum. This usually occurs when you cannot meet the full obligation of the debt, so a lender provides you a personal loan at an amount slightly less than you would owe if you paid off the existing loan. The original lender may agree to this if you would otherwise default on the debt.

  • Consolidation is typically a process of both of the above. You are paying off multiple loans with one loan. The debts should be settled at a lower total sum than you would otherwise owe, and your new loan should have a lower interest rate.

Benefits of Modification

The main benefit of modification is a more affordable or less expensive loan. Most people seek modification because circumstances have changed and they feel they can get a better deal now than they did in the past. These circumstances may include a better credit score, a higher income or even external factors like a lower national prime interest rate.

There is also a possibility a borrower can no longer afford the initial loan. Instead of staying in a loan that was agreed to some time ago, you can achieve a loan that meets your current needs and financial abilities. Modification can lead to lower or fewer monthly payments. Extending a loan through lower monthly payments is typically an easier sell to your initial lender. In this case, the lender will be making more money off of your contract instead of less money, which would be the case with some refinancing or settlement agreements.

Risks of Modification

There are a number of drawbacks to modification to be aware of.

  • First, there are usually fees associated with the process. This is particularly true if you received your initial auto loan through a dealership. Dealerships tend to have higher fees than banks for prepayment, modification or other concerns.

  • You will see your credit score drop when you modify your loan. Lenders do not like modification because it generally means they will make less on the deal than they initially expected. In order to dissuade individuals from modifying, they use a credit score drop as a disincentive.


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