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Loan Modification vs. Refinance: Which One Is Better?

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Loan modifications and mortgage refinance are ways to save money by lowering your monthly payments. But, when deciding which alternative to use, keep in mind that these two strategies are very different. Read to know more about loan modification vs. refinance. 

What is a loan modification? 

A loan modification alters the conditions of your mortgage in order to reduce your monthly payments. It can help you avoid foreclosure if you have financial difficulties preventing you from paying your mortgage. If you want to modify your house loan, you must first speak with your lender. Since you pay your mortgage payments to them, they are the only ones who have the authority to modify your loan. However, your loan servicer may agree to one or more of the following changes if you are qualified for a loan modification: 

  • Reducing interest rates 
  • Extending your loan duration  
  • Changing in loan type  
  • Reducing your principal  

To help your lender decide whether and how to modify your loan, you must give documentation of your change in financial circumstances. 

What is a mortgage refinance? 

A mortgage refinance replaces your existing house loan with a new one. Also, unlike a loan modification, homeowners seeking a refinance won’t need to provide evidence that they are struggling financially or in danger of losing their house to foreclosure. 

Contrary to popular belief, you must meet certain requirements and show that you have the ability to repay the new loan unless you are refinancing into a VA or FHA loan. And your mortgage must normally be current as well. 

loan modification vs. refinance

When should you get a loan modification 

A loan modification can make sense if you have trouble making your mortgage payments on time. Forbearance agreements can be very lenient for homeowners who are unemployed. Lenders, however, anticipate that borrowers will start paying payments once those forbearance periods are through. A loan modification is your best choice if: 

You could change your loan duration 

If your monthly payment is too high, your lender may raise the term from 15 to 30 or 30 to 40 years. This extends the period you have to repay your loan and lowers your monthly payments. 

You could reduce the interest rate 

It might be possible for you to modify your loan and get a lower rate if interest rates are presently lower than they were when you locked in your mortgage. This action reduces your monthly payment. 

You could an alternative loan type 

Your first loan may have been an adjustable-rate mortgage. That loan could become fixed rate as a result of the modification.  

Because they don’t need a good credit score or evidence of income, modifications are appealing to troubled borrowers. Loan modifications typically offer mortgage relief right away, whereas refinancing may take 30 days or longer. Loan modifications do not allow borrowers to access cash (unlike cash-out refinances), but they do not stop homeowners from selling their houses. 

When should you get refinancing   

Refinancing can make sense if your mortgage payments are current. A loan modification modifies your current loan, which is a key distinction between it and a refinance. In contrast, refinancing involves replacing your current loan with a new one. Moreover, there are nominal fees associated with loan changes, often a small administration fee. As a refi is a new loan, it has significant closing charges. Here are some explanations as to why refinancing might make sense: 

Possible reduction in interest rate 

Refinancing is typically done to lessen your mortgage interest rate. Calculate your break-even point, or how long it will take you to offset the closing expenses with reduced monthly payments, as your circumstances might not result in such significant savings. 

Your home is undergoing renovations 

Mortgage money is the most affordable kind of financing if you need to remodel your home in any way, including updating your kitchen, bathrooms, or other areas. You can use home equity from a cash-out refinance to pay for construction. If you have a hefty amount of equity and the improvements will increase the value of your home when you sell it, doing this makes the most sense.  

You have an FHA loan 

Federal Housing Administration loan recipients may make excellent refinancing candidates. This is due to the fact that FHA loans have high mortgage insurance rates that remain constant throughout the loan’s term. An FHA loan carries an annual mortgage insurance cost of 0.85 percent. If that monthly cost is gone, it may make sense to refinance into a traditional loan without mortgage insurance. 

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Loan modification: Pros and cons 

Pros Cons 
  • Lower monthly expenses. 
  • You can stay away from default and foreclosure. 
  • The same loan is kept, but with different terms. 
  • Must prove your financial difficulty. 
  • Your credit rating could suffer.  
  • Lender negotiations can be tiring. 

Refinancing: Pros and cons 

Pros Cons 
  • Low monthly payment. 
  • You can withdraw money.  
  • You can change the terms. 
  • You’ll need to have good credit and a job.  
  •  Closing expenses are high.  
  •  You’ll start over with your debt. 

How to modify a loan 

For loan modifications, each lender has their own set of rules and terms. Most of them need you to submit paperwork, such as a letter of hardship, bank records, tax returns, and evidence of income. 

How to refinance your loan 

In essence, refinancing involves looking for a new loan. You can save thousands of dollars over the course of your loan if you speak with different lenders and compare three or more offers. When you decide on your lender, you’ll need to present the same supporting documents you did when you applied for the initial loan: bank statements, pay stubs, and tax returns. You could require an appraisal, and title insurance can cost money. The procedure could take two months. 

Short-term alternative to loan modifications and refinancing 

There are more options besides refinancing and loan modification to reduce your home payments. If your financial situation is difficult, you may want to consider mortgage forbearance as a short-term solution to prevent foreclosure. With mortgage forbearance, you can temporarily stop making mortgage payments or pay less each month for a few months. The payments must be made subsequently. 

Bottom line: Loan modification vs. Refinance 

You decide to do refinancing; the repercussions of not refinancing are minimal. Although you might lose out on some savings, your house will remain intact. On the other hand, debtors are compelled to make a loan modification. Without a loan modification, default and foreclosure are imminent risks. 

You must be delinquent on your payments to be eligible for a loan modification, and you will likely be required to provide proof of your financial difficulty. You must be current on your mortgage payments and demonstrate that you have the income to cover the additional payments in order to be approved for a refinance. 

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