Loan Modifications and Refinancing: Which is Better for You?

These two terms have been around for a long time. The term “loan modification” however, while being an industry term for nearly long as there have been conventional mortgages, really came into being toward the end of 2008 and 2009 when toxic loans began to damage credit files, home sales and property valuations. Leading up to this period, new loan programs were introduced in order for buyers to finance a home using mortgages outside the conventional space. For a time, nearly anyone could obtain a mortgage to finance a home with as little documentation as possible, including no employment, income or assets. Certain lenders at that time would finance a loan application with the thinking that should the borrowers be unable to pay the mortgage they could always sell the property and pay back the loan. Yet at some stage there were no new buyers and owners who used these loan programs to buy a home found they couldn’t sell and they couldn’t pay back the home loan.

Loan Modification: How it Works

With a loan modification, the lender will adjust the existing note on the property to fit the owner’s current financial profile, most often due to a reduction in income. Homeowners who wish to modify their loan will apply for a modification with the lender and provide new financials verifying their current income and employment information. Modifying a mortgage means lowering the monthly payment to more accommodate the payment to current income by lowering the rate or adjusting the loan term. A lender doesn’t take a modification application lightly. The lender must be able to determine a loan modification is the last resort for keeping the owners in their home and not foreclose on a property. In addition, the loan guidelines ask there to be a determination made that the reduction in income is a short term situation and not a long term answer.

Loan Modification vs. Refinancing

A refinance can accomplish the very same when refinancing to a lower rate or refinancing to adjust the term of the loan. A lower rate naturally lowers the monthly payment but so too does extending the term. A 30 year term will have a lower monthly payment than say a 10 or 15 year term. But a refinance requires equity for a conventional mortgage and if the property is worth less than what is owed the owners can’t refinance. For those with a VA, FHA or USDA loan, there are provisions to refinance an existing mortgage to lower an interest rate or switch from an adjustable to a fixed.

What’s Next

So which is better, a modification or a refinance? For borrowers who currently do not have any credit issues and there is some equity in the property a refinance is probably the better choice. When a home loan is modified, the modification is noted in the credit report and can further harm credit scores. For someone who is having trouble paying back the loan and needs a lower payment to avoid foreclosure, the modification is the likely answer.