One of the most common strategies lenders use to lower a homeowner’s monthly house payment in a loan modification is to extend the term. For example, a homeowner who has a 30-year mortgage with 25 years remaining may have the term extended to 40 years or maybe even 50 years. Many homeowners simply cannot wrap their brains around the idea of paying on a house for over half their lives, but this can be the savviest strategy for achieving a long-term solution. I almost always advise homeowners to stretch out their mortgage for as long as they possibly can. Here’s why:

• Negotiating for the lowest monthly payment possible protects you in the event of a future financial setback.
• You can pay down the balance whenever you have a surplus to shorten the term.

Back in the 1980’s, many homeowners were refinancing into 15-year mortgages thinking that they would somehow magically reduce the term and cost them significantly less over the life of the loan than a 30-year mortgage. This is certainly true, but many of these same homeowners could accomplish their goal without refinancing simply by making payments equivalent of what they would be paying with a 15-year mortgage on their 30-year mortgage. The only difference is that a 15-year mortgage typically comes with a slightly lower interest rate.

To see how this works, google “mortgage calculator” and crunch the numbers for yourself. Here’s an example:

• With a 15-year $200,000 mortgage at 6% interest, the monthly payment is $1,687.71 and you pay $303,788 over the life of the loan.
• With a 30-year $200,000 mortgage at 6% interest, the monthly payment is $1,199.10 and you pay $431,676 over the life of the loan.
• If you pay $488.61 extra toward the principal every month on your 30-year mortgage, your payments are the same as those required by the 15-year mortgage, and you end up paying off the loan in 15 years for a total of $303,788 over the life of the loan.

In other words, assuming the interest rate is the same and the 30-year mortgage has no early-payment penalty attached to it, you can pay off a 30-year mortgage in 15 years and reap all the benefits of having a 15-year mortgage. The only difference is that the 30-year mortgage provides you with the flexibility to make a lower monthly payment if your financial situation makes it difficult or impossible to make the higher monthly payment. This flexibility can be key to helping you survive a temporary financial setback.

This term-extension strategy is similar to that of pay-option and flex-pay ARMs (adjustable-rate mortgages) but without the risks those products carry. They allowed borrowers to pay interest only, reduced principal and interest, or regular principal and interest. Problems arose because the only payment that proved to be affordable was the interest-only (negative amortization) payments, so borrowers were not paying down the principal. The term-extension strategy does not carry the same risks, because you’re paying down principal and building equity with every payment. You can pay down principal and build equity faster by paying extra toward the principal when you have extra money, but you give yourself a fall-back position in case money gets tight for a time. Essentially, you create your own pay-option loan – one that works in your favor.

Of course, you usually get a slightly lower interest rate with a 15-year mortgage, which can save you a little money each month and a good chunk of money over the life of the loan. For instance, suppose you have the same 15-year $200,000 mortgage at 5.5% instead of 6%. Your monthly payment will be $1,634.17 (about $50 less than the same loan at 6%) and you would save $9,637 over the life of the loan. Personally, I think this is a small price to pay for the flexibility to make a lower house payment.

When negotiating a loan modification, consider extending the term to stretch the payments out for as long as possible. When you can afford to pay extra, pay it, so you can pay down the principal earlier and build equity in your home faster. Just make sure that you clearly specify to your servicer that you want the extra amounts applied to principal, not to interest or escrow, and double-check your monthly statement to make absolutely sure that your servicer is applying the surplus to principal.

Ralph R. Roberts, GRI, CRS Award-Winning REALTOR® and Author Loan Modification For Dummies (avail. Summer 2009)