Can I Refinance After a Loan Modification?

A loan modification can provide much-needed relief if you’re struggling to make your mortgage payments. By changing the terms of your loan, a modification makes your monthly payments more affordable so you can avoid default or foreclosure. But can you refinance after getting a loan modification?

The short answer is yes, you can refinance after a loan modification, provided you meet certain requirements. Let’s take a closer look at how mortgage modifications work, when it makes sense to refinance post-modification, and what lenders look for if you want to refinance.

How Do Loan Modifications Work?

A loan modification permanently alters your original mortgage contract to make the payments more manageable. Common ways lenders modify loans include:

• Lowering the interest rate – This reduces your monthly payments and total interest costs.

• Extending the repayment term – Stretching out the loan term lowers the monthly payments by slowing down how quickly you pay off the principal.

• Adding missed payments to the balance – Known as capitalization, this increases the total amount you owe but gives you immediate payment relief

• Reducing the principal – Principal reduction lowers your monthly payments by forgiving part of what you owe

To qualify for a modification, you’ll need to show financial hardship due to circumstances like job loss, reduced income, major medical expenses or disability. You’ll also likely need to be at least 30 days late on your mortgage.

Modifications are designed to be permanent solutions for long-term hardships. But if your situation improves, you may eventually want to refinance your modified loan

When to Refinance After a Modification

Timing is an important consideration if you want to refinance post-modification. Here are some guidelines on when it could make sense:

• After 12 to 24 months of on-time payments – Most lenders want to see you’ve successfully managed the modified mortgage for at least a year before approving you for a refinance. This helps ensure you can handle the new loan.

• When your credit has recovered – Missing mortgage payments can significantly hurt your credit scores. It’s best to wait until your credit profile recovers before trying to refinance.

• If rates drop – Refinancing can save you money if current rates are at least 0.75% lower than your modified rate. You’ll need to weigh the savings against closing costs.

• When your income stabilizes – Lenders will evaluate your income and debt-to-income ratio. It’s best to wait until your financial situation has stabilized.

• After the modification seasoning period – Most lenders require your new loan terms to be in effect for at least 12 months before you can refinance through them.

Trying to refinance too soon after a modification likely won’t be successful. Patience and meeting the above criteria set you up for approval.

Refinancing Process After a Loan Modification

The process of refinancing after a modification is similar to refinancing any mortgage:

1. Review your finances. Check your credit, income, expenses and debts to get an idea of your financial health. This helps you determine if refinancing is feasible.

2. Research mortgage rates. Compare current rates to your modified rate to see if there’s room to save. Also research different loan types and terms.

3. Find a lender. Look for lenders familiar with refinancing modified loans. Compare multiple lender quotes.

4. Submit your application. Provide documents that verify your income, assets, debts, employment and previous loan modification agreement.

5. Get your new loan. After the lender approves your application, you’ll finalize loan documents and set a closing date.

6. Pay off your modified mortgage. Your new lender will wire funds to your old servicer to pay off the modified loan.

The keys are picking the right time to refinance, finding a lender willing to approve your application, and ensuring the numbers make sense for your situation.

What Do Lenders Look For When Refinancing a Modified Loan?

As with any mortgage, lenders want to confirm you are a low credit risk before approving a refinance. Expect lenders to carefully evaluate:

• Your credit scores – Most lenders require a 620 FICO score or higher. The better your credit, the more likely you’ll get approved.

• Payment history – On-time payments on the modified loan for 12 to 24 months are usually required.

• Debt-to-income ratio – Lenders analyze your total monthly debts against your gross monthly income. You’ll need a DTI of 50% or less.

• Loan seasoning – The modified loan terms must be in effect for at least 12 months in most cases.

• Loan-to-value ratio – The balance cannot exceed a certain percentage of the home’s value, often 80%. Additional equity strengthens your case.

• Recovered income/financial health – Lenders must confirm your income is stable and expenses are manageable with the new loan.

As long as you’ve re-established yourself as a financially healthy borrower, lenders should be willing to refinance a properly seasoned modified mortgage.

Pros of Refinancing After a Modification

If it makes financial sense, refinancing a modified mortgage offers several benefits:

Lower monthly payments – If you can get a lower rate, refinancing reduces your ongoing payments.

Shorter loan term – You may be able to shorten the lengthy term extended in the modification and pay off the balance faster.

Lower interest costs – The savings from a reduced rate can really add up over the life of the loan.

Ditch adjustable rates – You can swap an adjustable-rate modification to a more stable fixed-rate mortgage.

Cash-out equity – A cash-out refinance converts home equity to cash you can use for other financial priorities.

Improved credit – On-time payments can help rebuild your credit. Refinancing can give it an extra boost.

For many borrowers, being able to refinance into a better loan with more ideal terms is a light at the end of the modification tunnel.

Cons of Refinancing a Modified Mortgage

Refinancing does come with some potential drawbacks:

Closing costs – You’ll pay origination fees, appraisal fees and other closing costs. These can reach $5,000 or more.

Higher monthly payment – Your payment could go up if you refinance into a shorter-term mortgage from an extended modification.

Loss of modification terms – You lose any principal reduction or partial claim incentives gained through the modification.

Starting loan term over – Just as you begin making progress on payments during the lengthy modified term, you have to start repaying a new 30-year loan.

Future refinancing difficulties – Having a previous modification and refinance on your credit report could make getting approved tougher down the road.

For these reasons, you have to consider both the benefits and drawbacks before moving forward with refinancing a loan modification.

Alternatives to Refinancing a Modified Mortgage

If refinancing doesn’t make sense for your situation, a couple alternatives may be better options:

Pay as agreed – If you can afford the modified payment, continue doing so and rebuild your credit. Then you can refinance later when you have more equity.

Pay extra each month – Making an additional principal payment monthly speeds up how quickly you pay off the balance.

Save aggressively – Sock away money each month you might’ve used for refinancing. This builds savings over time.

Sell the home – If you have sufficient equity, you may want to sell and downsize to a more affordable mortgage.

Renegotiate terms – You could ask your servicer about tweaking the modification (via a rate reduction) to reduce payments instead of refinancing.

Do nothing – If you’re happy with the modification as is, you don’t necessarily need to make a change.

Refinancing is just one option. Weigh it against your unique situation to decide the right financial move.

The Bottom Line

Refinancing a mortgage after a loan modification is certainly possible if you meet typical underwriting criteria. The keys are rebuilding your credit, allowing enough time to pass after the modification, and ensuring the numbers make sense. Compare the pros and cons to determine if pursuing a refinance is right for you. With proper planning and realistic expectations, you can use refinancing to turn your modified mortgage into a better, more affordable loan.