Budgeting Debt

Loan Modification Vs. Refinance: The Difference

Being a homeowner can make many aspects of your life significantly easier. But homeowners still experience financial hardship just like anyone else. Experiencing financial hardship as a homeowner can make it incredibly difficult to afford your monthly mortgage payment. 

Whether you’re experiencing a temporary setback or struggling to budget your monthly expenses, on the whole, you might be considering loan modification or refinancing on your existing mortgage. Loan modifications and mortgage refinancing are both good options for borrowers in need of mortgage relief. You can determine which is the better choice for you through a deeper understanding of the differences between them. 

What Is Loan Modification?

Loan modification programs offer borrowers an alteration to the original terms of their existing loan. Loan modifications directly change the original conditions of your loan to help individuals experiencing financial hardship. So, the borrower is retaining their current mortgage through a loan modification refinancing rather than obtaining an entirely new loan. 

A loan modification can only be obtained through the borrower’s existing lender since they will need to approve the changes to the current loan agreement. Modifications that might be possible on a mortgage loan include loan term changes, interest rate reduction, structural changes, and principal forbearance. 

Your current lender is not obligated to agree to your request for a loan modification. It’s necessary to show evidence of economic hardship, but every mortgage lender has its own eligibility requirements for loan modification. 

Refinancing Your Mortgage

A mortgage refinance entirely replaces a borrower’s current mortgage with a new loan. Replacing an existing loan through refinancing will allow the borrower to change their loan terms so that they are more favorable or affordable to them. Through a cash-out refinance, borrowers can take out additional money through the equity built up in their homes. 

You don’t need to stick with your current lender when refinancing your mortgage loan. If you are pleased with your lender, then you can refinance with them to change the conditions of your existing loan. But if you are unhappy with your current lender, you can refinance a completely new loan with a new lender.

When refinancing your existing home loan, you can not only get a new lender but also lengthen your loan term for a lower monthly payment, lengthen your loan term to pay off the balance faster, qualify for a lower interest rate, change your loan type, or obtain a cash-out refinance.

The Differences Between Loan Modification vs. Refinance

While loan modification and refinancing may provide similar results, they are made to work for borrowers with different needs. There are several major differences between these two options and how they function. 

The most significant difference is that loan modification, unlike refinancing, simply restructures a borrower’s current loan while they are in the midst of a difficult financial situation. In refinancing, the homeowner obtains a new mortgage altogether that pays off the original loan and offers them new terms that work better for them. 

Who Is Eligible?

Eligibility for loan modification tends to look different from refinancing. To qualify for a loan modification, you must be able to demonstrate your financial hardship to the lender and, in some cases, you must be behind in your mortgage payments. 

Demonstrating financial stress is not necessary to qualify for a refinanced mortgage loan. Many homeowners who have a good payment history and credit score will be eligible to refinance if they have sufficient equity in their home. 

How It Works

When you apply for a refinance on your mortgage, you will be signing an entirely new contract with new terms and a new schedule of monthly payments. A mortgage modification can offer you some changes to your current loan terms while maintaining your existing mortgage. 

Each lender has its own process for loan modification and refinancing. However, you are unlikely to qualify for a loan modification with your current lender if you cannot show proof of hardship in your personal finances. You will need to provide your loan servicer with proof of income, your most recent tax return, bank statements, and a hardship letter explaining your financial situation.

When To Get a Loan Modification

There are specific circumstances where a loan modification will make more sense than your standard refinance. A loan modification will make the most sense when you are experiencing great difficulty affording your monthly payment. For instance, if you’ve missed several of your mortgage payments and will not be able to get current shortly, it will not be possible for you to be approved for a refinanced loan. 

Loan modification is also a good choice if your mortgage is underwater. An underwater mortgage loan is when you owe more on your house than it is currently worth. When your home equity is less than your loan balance, you won’t be able to get approved for refinancing. Additionally, a loan modification may be able to get you a reduction on your principal balance if you are attempting to avoid foreclosure. 

When To Refinance Your Mortgage

Refinancing is a preferred option over loan modification when you are in a good financial position, and you want to leverage that for better loan terms. For example, let’s say you have a significantly higher credit score than when you first applied for your mortgage. In that instance, you could apply to refinance with your current credit score and likely receive a much lower interest rate. 

You might choose to refinance when you want to borrow additional cash using your home equity. If you have a high credit score and a good monthly payment history, you could take out more money using the equity you’ve already built up in your home. Doing this is only possible with a cash-out refinance and not a loan modification. 

Benefits & Drawbacks of Loan Modification vs. Refinance

The most significant benefit that can come with reaching out to your lender to request loan modification is to avoid foreclosure when you’ve missed several mortgage payments. Oftentimes, lenders would rather work with you to come to a beneficial solution than have you claim bankruptcy or have the house foreclosed on. By requesting loan modification, you can ease the burden of your mortgage loan by decreasing your monthly payment or getting temporary mortgage forbearance until you get back on your feet. 

When refinancing your home loan, you might choose to switch from an adjustable-rate mortgage to a fixed-rate loan which would give you the benefit of a predictable monthly payment. You might also be able to access a lower mortgage payment or a lower interest rate through refinancing. 

As with most things, there will be potential downsides to both loan modification and refinancing. Getting a loan modification will negatively impact your credit report, which can have long-lasting financial consequences. With a refinance, the loan application will be just as lengthy as when you first bought your home, and you will have to pay full closing costs once again. Refinanced loans can be difficult to qualify for as well, meaning that you could end up being denied for the new loan.  

Budgeting Your Monthly Mortgage Payments

Organizing your monthly budget can be challenging when you’re experiencing some financial difficulties. If loan modification or refinancing isn’t an option or the lowered payments are still hard to afford, you may need to alter your budget so you can continue to make all your mortgage payments on time each month. Here are a few tips that might help you budget your expenses better: 

Examine Your Current Monthly Budget

When you are a homeowner, your entire budget should revolve around your mortgage payment, as it is probably your largest expense. If you are struggling to make your monthly payments, it might be a good idea to re-evaluate your budget. First, you will need to take stock of how much you spend on each fixed expense and what percentage of your budget is made up of your mortgage’s monthly payments. 

Review Your Needs vs. Wants

It can be difficult at times to figure out what expenses are necessary and which are wants that you can cut back on. It can be simpler to think of necessary expenses as things that you cannot live without, such as food, shelter, utilities, and healthcare. Everything else that is not a need is a want. 

It’s not possible nor realistic to live on a budget that only accounts for your needs as that is simply unsustainable. However, you can re-imagine your budget so that it is needs-based with a minimization of unnecessary expenses. You can still live comfortably but sparsely while you are getting back on better financial footing. 

Re-Arrange Your Budgetary Proportions 

Reducing the percentage of your budget that you put towards wants will increase the amount of money you have for your needs. If you are struggling to make your mortgage payment but can’t obtain a loan modification, you may be spending too large of a portion of your income on unnecessary expenses. 

See if there is anything you can cut out like subscriptions you can do without or cooking meals at home instead of ordering take-out. Shifting your budgetary proportions will increase the cash you have to handle your mortgage. 

Minimize Your Other Debt

Your monthly payments could be unaffordable because of the other debts you are juggling. It can be difficult to pay all your bills when you are juggling incredibly high credit card minimums or loans with monthly installments. Minimizing your other debt as much as you are able will make a significant difference in your budget concerns. Paying off other debt will allow you to reroute all that cash towards the repayment of your mortgage loan.

References:
Loan Modification Vs. Refinance | Rocket Mortgage
What is mortgage loan modification? Is it a good idea?