It goes beyond simply reducing your monthly payments. The results of a loan modification and a refinance may be similar—a lower monthly payment or interest rate on your mortgage—but they are intended for two different kinds of homeowners. Loan modifications restructure an existing loan's terms for borrowers who are having financial difficulties. In contrast, refinancing entails taking out a new mortgage with better terms in order to pay off your existing loan. As a result, each has very different requirements, benefits, and drawbacks. Find out more about loan modification vs. refinancing to determine which financing option may be most suitable for you.
Major Points
- Loan modification and refinancing are two tools you have at your disposal if you're trying to lower your monthly mortgage payment.
- A refinance is a new loan that replaces your current mortgage and has better terms than a loan modification, which restructures the terms of your current loan.
- You may qualify for a loan modification if you're having trouble making your current mortgage payments.
- Homeowners with good credit and payment records can benefit from refinancing by switching to a more advantageous mortgage.
What Distinguishes Refinancing from Loan Modification?
Loan Modification Refinancing What Happens Continually renew the existing loan, but with modified terms (interest, duration, etc.) Pay off debt and start a new mortgage. Eligibility Must show financial difficulty or, in some cases, be behind on their mortgage payments. Good payment history and credit are required. Adequate equity in the home is required. Application Process Working directly with the lender; proving financial need, and disclosing financial information Must meet income and credit requirements and have a significant amount of home equity (as determined by an appraisal). Potential Benefits Reduce your monthly payment and interest rate to avoid foreclosure A new loan that is either of a different type, with a shorter term or a lower interest rate (e.g., trade ARM for fixed rate) Drawbacks Cost of loans will go up overall; credit scores could decline Closing costs and stricter requirementsComparing Loan Modification and Refinancing
The main distinction between these two options is that while a refinance entails taking out a new mortgage loan, a loan modification merely restructures your current loan.Eligibility: refinance versus loan modification
Loan modifications are typically reserved for borrowers who are going through financial hardship. In contrast, refinancing is for borrowers who are in good financial standing but want a different home loan that offers them some benefit. Most lenders demand an explanation of your financial hardship and supporting documentation before considering your application for a loan modification. Some people might not consider loan modification unless you have already missed payments. If the government backs your loan, there may also be unique loan modification programs available. It is always best to call your lender to find out if you might be eligible for a loan modification. Refinance applicants must meet all lender requirements, including those pertaining to credit history, debt-to-income (DTI) ratio, and other factors, as well as have a sufficient amount of equity in the home (which must be demonstrated with an appraisal).Benefits of Loan Modification versus Refinancing
Avoiding foreclosure or declaring bankruptcy are the main motivations for requesting a loan modification. Each type of loan modification—whether it lowers the principal balance, lengthens the loan term, lowers the interest rate, or switches to a fixed interest rate—is intended to lessen your burden by reducing the number of your monthly payments. Although lowering the interest rate and having a lower monthly payment are typically the main reasons for refinancing, some people may also want to shorten their loan term, switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage with more predictability, or switch from a Federal Housing Administration (FHA) loan, which requires paying mortgage insurance, to a conventional loan.Refinancing vs. Loan Modification Has Drawbacks
You must be in financial danger to qualify for a loan modification. Your credit score could be harmed if you skip payments while you wait for the approval. Even if you are accepted, it might be listed as a settlement, which would cause your credit to be negatively affected once more. Important: If you modify your loan to extend the term, you will typically pay more in interest over the course of the loan. A refinance's main drawbacks are that you must go through a thorough application process (like when you bought your home) and pay all closing costs. It might be harder to qualify if you don't have good credit or a consistent source of income (the process might be more difficult if you're self-employed, for example).Particular Considerations
Depending on your situation, you might want to take into account some special programs in addition to conventional loan modification and refinance options. Unlike a regular refinance, which requires you to have enough equity in your home, there are some special refinancing options available for homeowners with "underwater" mortgages—that is, mortgages that are higher than the value of their homes. If you don't want to undergo a full-fledged loan modification, you might also consider temporarily altering your current loan. In fact, asking for forbearance, where the lender consents to either lowering your payments or skipping payments for a predetermined period, can frequently make it simpler to get temporary assistance.What Is the Best for Me?
In the end, whether you should apply for a refinance or a loan modification will depend on your individual financial situation. If you qualify for a refinance, you may. Are you current with all of your payments and have good credit Do you believe you could be eligible for a lower interest rate than what you have now? Want a loan with a lower interest rate, a shorter term, or a different loan program? Stay there long enough to recoup the closing costs, if possible. If you qualify, a loan modification may be appropriate for you. Can't be approved for a refinance Are you having trouble making your mortgage payments, have you missed any, or do you think you won't be able to make any in the near future? Able to prove that you can afford the lower payment amount Asking yourself the following questions will help you decide between a refinance and a loan modification:- Are your finances stable, or are they shaky?
- Do you have a good credit score and payment history?
- Have you compared the short-term gains to the long-term effects of refinancing or modifying your loan terms? (You can do that by using a loan amortization calculator.)
- Are there any additional expenses I should be aware of?
The Bottom Line
Even though loan modifications and refinancing have some similarities, they are very different programs for various financial situations. You can choose what is worthwhile by evaluating your financial situation and identifying your goals.Questions and Answers (FAQs)
After a loan modification, Is refinancing possible?
There is nothing preventing you from refinancing following a loan modification, though some lenders might ask you to hold off for a specific time. But bear in mind that you might not immediately meet the borrower requirements for a refinance if you experienced financial difficulties that made you eligible for a loan modification.What happens following the approval of a loan modification?
You will be required to make a few timely payments as part of a "trial period plan" if your loan modification request is approved. The lender may then decide to extend the modification agreement for the remainder of the loan's term after you do.What choices do you have if a loan modification is rejected?
You can try appealing your lender's decision if they reject your request for a loan modification. After the servicer rejects your application, you have 14 days to file an appeal, and the lender has 30 days to consider it. You can think about other options like forbearance or bankruptcy if you are still denied at that point and are having trouble paying your bills.What is the price of refinancing?
Closing costs for a refinance can range from $5,000 to $8,000 depending on the size and type of the loan as well as your state and county.Can you lower your mortgage payment every month without refinancing?
In the event that you are eligible for a loan modification, you might be able to lower your monthly mortgage payment without refinancing. Another way to lower your monthly payment on private mortgage insurance (PMI) is to be eligible to have it removed due to an increase in the value of your home. Finding a less expensive carrier may also enable you to save money if your homeowner's insurance is included in your monthly bill.