Loan Modification vs. Refinance: How to Decide

The 2019 Survey of Consumer Finances found that about 30% of homeowners have less than $14,000 in assets to cover an unexpected drop in income.

If the pandemic and its economic fallout have decimated your emergency fund, reducing your housing expenses may be more necessary now than ever.

Loan modifications and refinancing are two ways for homeowners to lower their monthly mortgage payments.

What is a loan modification?

A loan modification changes the terms of your mortgage to make the monthly payments more affordable. It’s a strategy for avoiding foreclosure if you’re experiencing a financial hardship that’s preventing you from paying your mortgage.

If you’re interested in a home loan modification, you’ll need to talk to your loan servicer. That’s the company you send your mortgage payments to, and they’re the only ones who can modify your loan.

Tip: If your loan servicer isn’t helpful, try looking up your loan to see if it’s owned by Fannie Mae or Freddie Mac. If so, you may be able to get assistance through their Flex Modification program.

You can also find free foreclosure avoidance counseling through the U.S. Department of Housing and Urban Development.

If you’re eligible for a loan modification, your loan servicer may agree to one or more of these changes:

• Interest rate decrease
• Loan term extension
• Loan type change
• Principal reduction

You’ll need to provide your servicer with evidence of your change in financial circumstances to help them decide whether and how to modify your loan.

What is a mortgage refinance?

A mortgage refinance replaces your current home loan with a new one, and you don’t have to refinance with your current lender: you can shop around.

Also, unlike a loan modification, homeowners hoping to refinance won’t have to demonstrate that they’re experiencing financial hardship or at risk of foreclosure.

In fact, it’s quite the opposite: Unless you have a VA or FHA loan and you’re refinancing into the same loan type, you’ll have to qualify and demonstrate that you can repay the new loan. You’ll typically need to be current on your mortgage, too.

With refinance rates so low, it’s an ideal time to consider getting a new mortgage, and Credible can help you find great rates. You can compare prequalified rates from our partner lenders without affecting your credit score, all by filling out one simple form.

When a loan modification makes sense

Loan modifications are best if you’re:

• Behind on monthly payments
• Underwater on your mortgage

Loan servicers generally only approve loan modifications as an emergency measure for borrowers who are vulnerable to foreclosure.

A homeowner might find themselves in this situation if they’ve lost their job, had their hours cut back, been unable to work due to caretaking responsibilities, or experienced a serious illness or injury.

Another circumstance that can cause homeowners to struggle is having an adjustable-rate mortgage whose rate has increased, making the monthly payment unaffordable.

Pros

It makes sense to consider requesting a loan modification if you’re having financial problems and you don’t want to lose your home.

Here’s how a loan modification could help:

• It could be faster than refinancing. One of the nation’s largest mortgage lenders, Wells Fargo, says it usually gives homeowners a loan modification decision in fewer than 30 days once you’ve supplied them with the necessary paperwork. Refinancing a home usually takes six to eight weeks.
• You might end up with free home equity. While this outcome is highly unlikely, if your loan servicer reduces your loan principal, you will increase your home equity. However, debt forgiveness can be subject to income tax.

Cons

Modifying your mortgage may be your best option for avoiding delinquency or foreclosure, but it could still have negative consequences.

Here are some drawbacks to modifying your home loan:

• It could lower your credit score. Your loan servicer might report the loan modification to the credit bureaus. Because a loan modification shows you’re experiencing financial challenges, it could lower your score. The effect, however, will be less serious than a foreclosure.
• You can’t take any cash out. If your mortgage isn’t the only expense you’re struggling to pay, a loan modification may not solve all your problems — though the cash freed up from a modified monthly payment can help.

When a refinance makes sense

Refinancing is best if you:

• Have some equity in your home
• Are in generally good financial shape
• Want to save money by getting a lower mortgage rate

Because refinancing requires you to get a new mortgage, you’ll have to pay closing costs.

Tip: You’ll want to calculate the breakeven point where your monthly payment savings will balance out these costs before you decide whether to refinance.

If you’re planning to stay in your home beyond the breakeven point, refinancing may be a good choice.

Getting quotes through Credible can help you calculate a preliminary breakeven point and decide if you want to proceed. You can compare current rates from our partner lenders using the table below.

Learn More: Mortgage Refinancing Calculator

Pros

Refinancing does require pulling together some paperwork and going through the loan process, but the potential savings can make it worth the effort.

Here are some key advantages of refinancing over loan modification:

• You can shop around. Loan modification may not give you many options because you’re limited to what your loan servicer offers you. Refinancing allows you to get quotes from multiple lenders who know they’re competing to offer you the best deal.
• You can take some cash out. With a limited cash-out refinance, you could get up to $2,000 cash back at closing. And if you have enough equity, you could do a full cash-out refinance and get much more. With the latter, you can use the money however you want, and it could help you better manage additional financial challenges that aren’t related to your mortgage payment.
• It won’t count as a debt settlement. Your lender isn’t forgiving any money you owe when you do a refinance.

Cons

For some homeowners who need financial relief, refinancing won’t be the right option.

These drawbacks of refinancing might make loan modification a better choice:

• It’s harder to qualify for. Lenders will want to see that your debt-to-income ratio and credit score make you a financially strong candidate to repay a new mortgage.
• It may take more time. If you’re about to miss your next mortgage payment, refinancing may not help you fast enough. The average time to refinance a mortgage in October of 2020 was 57 days according to Ellie Mae, a mortgage industry technology solutions provider.

Also read: A Guide to Short Refinancing

Want a short-term alternative to loan modifications and refinancing?

Loan modification and refinancing aren’t the only ways to find relief from your mortgage payments. If you’re experiencing challenging financial circumstances, you can look into mortgage forbearance as a short-term strategy for avoiding foreclosure.

Mortgage forbearance gives you a temporary break from making your mortgage payments or lets you pay a smaller amount for a few months. You’ll need to make up the payments later.

From March through June 2020, about 5.6% of homeowners took advantage of mortgage forbearance to help stay afloat.

Tip: If you need a long-term solution, a loan modification or refinance may be a better option. You could also try out forbearance first and see if it’s helpful enough to get you through a rough spot.

The pandemic has made it easier than ever to get mortgage forbearance, and lenders are not supposed to report forbearance on a negative item on your credit right now.

Which method of changing your mortgage payment would help you most?