New FHA Modification Rules

By Vena Jones-Cox

If you don’t do subject to, this probably isn’t going to interest you a lot, but if you do, here’s a weaponized autism evaluation of the new FHA modification rules for ya:

I just talked to about the fifth FHA-insured loan holder in three months who re-defaulted after a loan modification in which both the interest rate AND the payment went UP.

I KNEW something was up, because after years of hearing, “We’ll just take all those back payments and shove them into a zero-interest, zero-payment partial claim second that you don’t have to worry about until you sell the house or pay off the first mortgage,” this seemed like a pretty clear change in HUD policy.

So I finally got curious and looked it up this morning.

And sure enough, the policy really did change on October 1, 2025.

Before then, FHA servicers were still using the COVID-era loss-mitigation rules. One of the most common solutions was to put the missed payments into a “silent second” owed to HUD—the thing called a “partial claim mortgage.”

Those were great for homeowners and, assuming we understood that the time bomb was there, for us as sub to buyers.

Because those partial claim mortgages have no interest, no monthly payment, and they let the homeowner keep the original first mortgage—with its original interest rate and payment.

That was obviously a HUGE benefit to someone with one of those 2.5%, 3%, or 4% loans.

But…and maybe rightly so, given that all of this generosity falls on the American taxpayer, HUD ended that program on September 30, 2025 and replaced it with a new, more restrictive loss-mitigation “waterfall.”
The zero-interest partial claim second still exists. But now servicers can—and per my recent experience, often DO—instead offer an actual loan modification that resets the first mortgage to something close to the CURRENT market interest rate.

So someone with a 3.5% FHA loan can suddenly end up with a modified loan at 6% or 6.5%.

This is sometimes combined with a partial claim or an extension of the loan to 40 years to keep the borrower’s payment ‘affordable’—but the result is that they build less equity over time, so even if the modification works and they keep the house another 5 years before deciding to sell it, they may still owe more than it’s worth by then.

Oh, AND ALSO every one of these sellers I’ve talked to STILL had a higher payment than they started with.

So why do you need to know any of this?

Because it SHOULD create a conundrum for investors trying to buy properties subject to the existing financing.

Our first responsibility, always, is to help people.

And if you’re talking to a seller who genuinely wants to keep the house, I would never advise them not to pursue a loan modification just because I might want to buy it subject to the existing 3% loan.

If keeping the house is realistic, they should explore every available option.

But they also need to understand that the new loan modification may not leave their 3% loan intact. It might convert it into a 6.5% loan with a higher payment.

Before signing it, the seller needs to do a very honest gut check:

“If I couldn’t consistently make the old payment, can I—and will I—really make this new, higher payment?”

Because if they accept the modification and re-default six months later, their options for selling that house without a foreclosure sale might be significantly worse.

The investor who could have bought the property subject to a 3.5% mortgage, caught up the arrears, given the borrower some moving money, and created an affordable solution may not be able to make the same deal work subject to a 6.5% mortgage.

But there’s another kind of seller, of course.

That seller is emotionally and financially done with the house. They don’t really want to keep it. Maybe they just need time to move, want to remain there until the school year ends, or need several months to make their next plan.

In that situation, modifying a perfectly valuable 3.5% loan into a 6.5% loan may actively work against what the seller actually needs.

At 3.5%, you might be able to:
• Catch up the existing loan
• Preserve the low interest rate
• Take responsibility for the property
• Allow the seller to stay temporarily
• Create a short-term payment the seller can actually afford
• Give the seller time to make an orderly transition instead of waiting for the next default notice

That doesn’t mean “talk sellers out of loan modifications so you can get their low interest loans.”

It means finding out what the seller truly wants BEFORE treating a loan modification as the automatic answer.

If they want to keep the house—and can realistically afford the modified payment—help them apply for that loan mod.

If they’re done with the house and simply need time, don’t assume a modification that raises the rate and payment is doing them a favor.

And in every case, make sure that the borrower and his advisors look at the actual proposed modification before it’s signed:

• What is the new interest rate?
• What is the new total payment?
• How long is the new term?
• How much will be owed in the HUD partial claim second?
• Can the seller truly afford it?
• And does accepting it actually move the seller toward what they want?

Because “the foreclosure has been stopped for now” and “the seller’s real problem has been solved” are often two very different things.