If you’re looking for better mortgage terms, loan modification and refinance can be viable options to improve your financial health.
Financial struggles can happen to anyone, but homeowners have something big at stake: their house. If money has become more of a worry, it might be time to consider your options to make your mortgage payment more manageable. Among the routes you could go are loan modification and refinancing. Each one could make your payments more affordable, but key differences make one or the other a better option for some. Caitlyn Fitzpatrick, the author of this piece, has written about all different mortgage terms you should know and here she’s breaking down loan modification vs. refinance.
- What is a Loan Modification?
- Pros
- Cons
- See All 11 Items
What is a Loan Modification?
A loan modification is when a borrower wants to adjust their current loan terms with their mortgage lender. The result is usually a more affordable monthly payment. While each lender is different, you must generally prove financial hardship, such as job loss, divorce, illness or medical condition, military duty, unforeseen expenses and natural disaster.
“The modification request will be reviewed and there may be a change in rate, a term extension, forbearance or principal deferment to lower your monthly payment to make it more manageable. They don’t have closing costs, but you may have a loan fee,” says Pahm Foxley, vice president of mortgage lending at Wasatch Peaks Credit Union.
Pros
- Lower monthly payments
- Typically a quicker process than refinancing
- Better for your credit than foreclosure
- No closing costs
Cons
- Could negatively impact your credit score
- Greater total cost since repayment term is longer
- Typically only available if you’re already behind or at risk of falling behind on payments
What is a Refinance?
A refinance is swapping out your current loan for a new one that typically has better terms. There are two common types. A cash-out refinance taps into your home equity and means you’ll apply for a larger loan than your current one. If approved, you get paid the difference between the two loans (most people need it for remodeling, high credit card debt, etc.). Then, you’ll make monthly payments toward the new mortgage. You could get a lower interest rate, but your mortgage term will be extended. A rate-and-term refinance will give you a new mortgage, but the principal loan amount is the same as your current one. The benefit is a better interest rate or term length (or both).
“You are typically required to have strong credit, income verification, pay closing costs and often require an appraisal,” says Foxley.
Pros
- Lower monthly payments, interest rates and/or total loan cost
- Allows you to switch mortgage lenders
- Different types for a more personalized route
Cons
- Typically a slower process than loan modification
- Solid income and credit score are required for a better rate
- Potential closing costs of 2% to 5% of loan amount
How to Choose Between Loan Modification vs. Refinance
You need to remember that you might not qualify for a loan modification and/or refinance. So, the choice might not even be yours. Loan modification requires proving a hardship and your lender might not qualify your situation as the level of hardship they need. But if you are in an approved hardship, you probably won’t qualify for refinancing. “If you are able to refinance, that is typically the option that will be offered,” says Foxley.
A homeowner who lost their job and has fallen months behind on mortgage payments may be a better candidate for loan modification. On the flip side, a homeowner with a solid income and credit score who just got divorced and wants to keep their house even though they’re short on monthly payments on their own may benefit from refinancing. That’s why it’s important to talk with a professional so they can review your specific situation.
Alternatives to Loan Modification and Refinancing
The good news is that if neither loan modification nor refinancing make sense for your financial situation, there are other options:
- Forbearance: This allows you to temporarily pause or reduce monthly payments for a set time. Interest will continue to accrue, though.
- Repayment plans: If you’ve missed payments, you can contact your mortgage lender to see if you can set up a repayment plan. This means a portion of your past-due payments will be added to your regular monthly payments over a certain period.
- Deed-in-lieu of foreclosure: In a deed-in-lieu of foreclosure, the homeowner voluntarily transfers the home’s ownership to the mortgage lender. This prevents the foreclosure process, credit score hit, etc.
- Government assistance programs: Each state has its own resources to help homeowners with financial hardships that are impacting their mortgages. Look up your state’s programs for more details.
- Home equity line of credit (HELOC): A HELOC allows you to borrow money based on your home’s equity. For example, if you have $300,000 left on your mortgage and your home is appraised for $400,000, you could access up to $100,000.
- Selling the home: If you’re in a situation where you’re looking for ways to keep your home, selling it is probably the last thing you want to do. However, it might come down to that. So, consider all options, even when they’re tough.
Why You Should Trust Us
Since 2010, Benzinga has focused on delivering the most reliable, up-to-date information in the financial space. Whether you’re a potential homebuyer hoping to purchase your first home or an investor who needs insight, we’re here to help your financial health, including when it comes to buying a home. About 25 million readers trust us monthly to answer their most important questions.
Caitlyn Fitzpatrick, the author of this article, has been an editor and writer since 2014. Although her background is in commerce journalism, she has been working with Benzinga to bring her smart-buying expertise to readers. For this story, we spoke with Pahm Foxley, vice president of mortgage lending at Wasatch Peaks Credit Union, to provide real-world insight on loan modification vs. refinance.
FAQ
How much does a loan modification lower your payment?
How much lower your mortgage payments could go depends on what you qualify for. Not everyone will get the green light on the same term and rate. “It’s also good to note that varies widely based on changes to interest rate and loan term and loan structure,” says Foxley. “For example, your rate may change from 6% to 4% or your term may be extended from 25 years to 30 years.”
Is it hard to get approved for a loan modification?
Not necessarily, but the purpose of a loan modification is to help a homeowner who’s going through a financial hardship, such as losing a job, a sudden death, a divorce, etc. However, not every lender defines hardship the same way, so they may try to steer you toward a different solution, like refinancing.
What is the debt-to-income ratio for loan modification?
Again, that depends on the lender. Some might be more forgiving of a less ideal debt-to-income (DTI) ratio. “Most programs aim for housing DTI [ratio] below 31% (that is principal, interest, taxes and insurance vs. gross monthly income),” says Foxley. “Total DTI must be below 55%, although many lenders prefer under 50% or even closer to 40% to 45%. Lenders have discretion over the DTI [ratio] requirements for each type of loan.”
Sources
- Pahm Foxley, vice president of mortgage lending at Wasatch Peaks Credit Union
About Caitlyn Fitzpatrick
Caitlyn Fitzpatrick has been a professional writer and editor since 2014 and entered the commerce journalism world in 2017. She’s passionate about helping readers make smart buying decisions by using data insights and interviewing experts. Most recently, Fitzpatrick was the Senior Shopping Editor at Trusted Media Brands, where she led affiliate content on Reader’s Digest. In addition to Benzinga, Fitzpatrick’s work can be found in a range of publications, including U.S. News & World Report’s 360 Reviews, Today’s Parent, Betches, WhatToWatch.com, PS (formerly Popsugar), and more.
