Loan Modification vs Refinancing

Loan modification and refinancing are two great ways to lower a monthly mortgage payment. Most homeowners want to reduce their mortgage payment. Others, however, have no choice – they must reduce their mortgage payment to avoid foreclosure. The new government program, Making Home Affordable, provides two ways for financially struggling homeowners to lower their mortgage payments: loan modification and refinancing. Let’s examine the similarities and differences between the two.

Same Goal: Lower Mortgage Payments

Both loan modification and refinancing are designed to lower a homeowner’s monthly mortgage payment. Lenders can lower the monthly home loan by reducing the interest rate, extending the loan term, or charging no interest on the principal balance.

The key difference between the two methods is that, with a refinance, homeowners receive a brand new, low-interest mortgage. With loan modification, however, the lender simply modifies the existing mortgage so that the payments are more affordable.

Mortgage refinancing is a permanent solution for lowering one’s monthly mortgage payment, because it locks a lower interest rate for the remaining loan term. Loan modification, however, is a temporary fix. After five years at the modified rate, the rate may gradually increase to a set maximum rate. If you choose to modify your loan, be sure to ask your lender what the set maximum interest rate will be after five years at the modified level.

Refinance  and Loan Modification Requirements

To qualify for the government sponsored refinance program, borrowers must have a mortgage that is owned or guaranteed by Fannie Mae or Freddie Mac, and have a loan-to-value less than 125 percent. Borrowers must be current on their mortgage payment.

Like a refinance, loan modification mortgages must be owned or guaranteed by Fannie Mae or Freddie Mac and have a loan-to-value less than 125%. Unlike refinancing, loan modification applicants can be currently behind on their home loan payment. Loan modification applicants must write a letter detailing their current financial strain and show a significant need for a lower monthly mortgage payment. You must show that your monthly mortgage payment is at least 31% of your gross monthly income.

What Do Lenders Recommend?

Since mortgage refinancing involves a brand new loan, there is a significant amount of paperwork and required documentation to qualify. Lenders generally recommend refinancing to homeowners with higher credit scores who are up-to-date on their home loan payments.  However, with the new government-back program, refinance is more streamlined and requires significantly less paperwork.

Since a loan modification simply changes the existing home loan, there is much less paperwork than with refinancing; therefore, modifications are generally easier and faster to receive. Lenders suggest loan modification to homeowners who currently have significant financial strain, are already be late on their home loan, and are unable to qualify for refinancing.