Loan Modification vs Loan Refinance: A Detailed Comparison

Deciding whether to pursue a loan modification or refinance can be a difficult choice for many homeowners. Both options allow you to change the terms of your mortgage but they work in very different ways. In this comprehensive guide we’ll explain what loan modifications and refinances are, key differences between the two, when each option makes the most sense, and step-by-step instructions for pursuing either route.

What is a Loan Modification?

A loan modification directly alters the terms of your existing mortgage with your current lender. You do not take out a new loan. Instead, your lender agrees to modify the original loan agreement.

Some potential loan modification changes include:

• Lower interest rate – If current rates are below your existing rate, you may qualify to have your rate reduced. This lowers your monthly payment.

• Extended repayment term – Getting more time to repay the loan by extending the length of the mortgage reduces your monthly payments.

• Different loan type – You may be able to change from an adjustable-rate to a fixed-rate mortgage to get a predictable monthly payment.

• Principal forbearance – Your lender sets aside a portion of your unpaid principal balance to be paid later. This temporarily reduces your monthly payments.

• Principal reduction – Your lender agrees to permanently reduce the amount you owe on the mortgage. This lowers your payment and total interest paid over the loan term.

The key benefit of a loan modification is that you get to keep your existing mortgage without the costs and credit impact of getting a new loan. However, you can only pursue a modification directly through your current lender and must prove financial hardship to qualify.

What is Refinancing?

When you refinance, you take out an entirely new mortgage loan to pay off and replace your current one. Refinancing allows you to change your loan amount, interest rate, term length, and type of loan.

Reasons you may want to refinance include:

• Shortening your term – Going from a 30-year to 15-year mortgage shortens the repayment period. You’ll pay less interest but have a higher monthly payment.

• Lower interest rate – If rates have dropped since you got your existing loan, refinancing could secure you a lower rate and reduce your payments.

• Switching loan types – You can go from an adjustable-rate to a fixed-rate mortgage to lock in a steady payment.

• Taking cash out – A cash-out refinance lets you borrow more than you currently owe to tap your home’s equity.

• Consolidating debts – You can roll high-interest credit card, auto, or student loan balances into your new mortgage at a lower rate.

Refinancing is generally easier to qualify for than a modification, but comes with upfront costs like appraisal fees, closing costs, and potentially higher rates than your current mortgage.

Key Differences Between Modification and Refinance

Now that you understand the basics of each option, let’s look at some of the main differences:

• Existing lender vs. new lender – To modify you must work with your current lender, but you can choose any lender when refinancing.

• Qualification – Modification requires proving hardship while refinancing has standard eligibility requirements.

• Costs – A modification has no closing costs while refinancing comes with upfront fees.

• Application process – Modification involves negotiating directly with your servicer. Refinancing follows standard loan application procedures.

• Credit impact – An approved modification may hurt your credit score if you were current on payments before. Refinancing typically won’t damage your credit.

• Loan payoff – With a modification, your existing mortgage stays in place and is altered. A refinance pays off your current loan and replaces it entirely with a new one.

When Does a Loan Modification Make Sense?

In certain situations, trying to modify your mortgage before attempting to refinance may be the better financial decision:

• You’ve missed payments or are at risk of default – To qualify for a refinance, you must be current on your mortgage. If you can’t catch up, modification may be your only option.

• Your home value has declined – If your mortgage balance exceeds your home’s value, you may be disqualified from refinancing until you have more equity. Ask your lender if you qualify for a modification.

• You need immediate payment relief – The modification process is usually faster. If you need a quick reduction in your payment, modification may get you help sooner.

• You have limited options – If your credit score or income makes it unlikely you’ll qualify to refinance, modification with your current lender may be possible.

• You recently refinanced – Most mortgages come with clauses preventing you from refinancing again too soon. If it hasn’t been long since you last refinanced, modification with your current lender may be your only choice.

When Does Refinancing Make More Sense?

In other situations, refinancing is clearly the better route to pursue:

• Interest rates have dropped – If current rates are significantly lower than your existing mortgage rate, refinancing could save you thousands in interest costs. Loan modifications rarely reduce rates substantially.

• You want to shorten your loan term – Refinancing is the only way to go from a longer term to a shorter one. This allows you to build equity and pay off your mortgage faster.

• You need cash from your equity – A cash-out refinance lets you tap your equity for anything you want. Modifications do not allow you to take cash out.

• You want to change loan types – Switching from an adjustable-rate to a fixed-rate mortgage can only be done with a refinance. Loan modifications rarely allow for a loan type change.

• Your credit has improved – If your credit score was poor when you got your current mortgage but is now much higher, refinancing could score you better rates and terms.

How Do I Apply for a Loan Modification?

Since modifications are handled directly between you and your current lender, the application process will vary. Here are some common steps to help guide you:

1. Contact your loan servicer – Call and ask to speak with a modification specialist. Be prepared to explain your financial hardship and why you require mortgage relief.

2. Gather documentation – Your lender will provide a list of documents like bank statements, tax returns, income statements, and hardship letters you’ll need to submit.

3. Complete application forms – Fill out all modification request forms your servicer provides completely and accurately.

4. Submit your application – Send all documentation to your lender according to their instructions. Follow up if you do not receive confirmation they received your full packet.

5. Negotiate modified terms – Be prepared to provide additional documents to verify income and hardship. Negotiate the specific terms you need to afford your mortgage long-term.

6. Get final approval – If you and your lender reach an agreement, they will send final modification paperwork for you to sign. The changes will then be permanently applied to your existing mortgage.

What is the Process to Refinance My Mortgage?

Refinancing follows a more standardized process across lenders:

1. Check your equity – Make sure you have adequate equity to qualify for the type of refinance you want. Requirements vary by loan program.

2. Compare lender refi rates – Research current rates across multiple lenders and loan types to find the best deal. Leverage online mortgage rate tools to compare options.

3. Compile your documentation – You’ll need W-2s, paystubs, tax returns, bank statements, and other info to begin your application.

4. Complete loan application – Apply with the lender offering the optimal rate/fees combination you found. Be thorough and honest on your application.

5. Get pre-approved – Your lender will approve you for a loan amount based on your financials, credit, and equity. This pre-approval locks in your rate.

6. Property appraisal – An appraiser will evaluate your home to ensure its value supports the new loan amount.

7. Underwriting review – Your full application will go through an intensive underwriting process to confirm all details and formalize approval.

8. Closing & funding – Once approved, you’ll sign final loan documents. The lender then disburses the new loan proceeds to pay off your old mortgage.

Whether pursuing a loan modification or refinance, the most important thing is to fully understand your options. Evaluate your specific financial goals and scenario to decide which route makes the most sense. Being strategic and educated will help ensure you make the best choice to provide mortgage relief or savings.