A loan modification is the most common form of loss mitigation and can consist of the reduction of the principle balance, increasing the term of the loan, lowering the interest rate, forgiveness of past due payments, or any combination of these characteristics. The principle purpose of this process is to reduce the likelihood that an individual will default on his or her loan or mortgage thereby forcing the loaning institution to foreclose on the property or asset. The loaning institution would rather not pursue a foreclosure process. It is expensive and severely limits the ways in which the bank or financial institution can recoup their financial losses associated with the defaulted loan. Thus, loan modification is a popular manner in which banks attempt to make it easier for debtors to repay their loan obligations.

One of the first modifications that a financial institution will offer is usually an increase in the term of the loan. A term is a period of time that the bank gives a debtor to repay a loan obligation and can range from three months for a short term loan to fifteen or thirty year terms for long term obligations. When a bank increases the length of the term for an obligation they are simply giving the debtor more time to repay the debt. While this process is often the most common form of a loan modification, it usually does not lead to the successful redemption of the financial obligation. It only provides the debtor more time to fall further behind.

In order to help stop this from happening, a bank may also offer to forgive previously past due payments. When this happens it is like starting with a clean slate. The debtor, free of the financial burden of past due payments, is free to begin paying the payments once again. However, many banks will simply add the forgiven past due payments to the initial loan balance. Thus, they are not really forgiven only rolled back into the initial loan.

Another way that banks try to help individuals repay a mortgage is to lower the associated interest rate. An interest rate is a percentage that is, in essence, a charge for extending the loan. It is usually compounded monthly, but can also e compounded annually, bi-annually, or even bi-monthly. An interest rate can vary greatly from bank to bank, and can mean thousands of dollars of difference from one loan to another. When people start to fall behind on payments, they begin to only pay the minimum payment which is typically only the interest on the initial loan. By lowering the interest rate a bank can make it easier for a debtor to begin to payback the principle thereby, assuring repayment of the loan.

The ultimate and usually last approach to reclaiming a past due loan is to forgive part of the initial debt. This is a highly unlikely approach because it defeats the purpose of the process which is to make it easier for the bank to reclaim the full amount of the extended loan. It is only pursued when the bank deems it likely that the loan will not be repaid otherwise.

When an individual begins to fall behind on loan payments, a bank will often extend the opportunity for a loan modification in order to ease the immediate financial burden and help ensure the repayment of the financial obligation. This is the most common form of loss mitigation.