Refinance vs loan modification: A guide to your options

Good things don’t always stay that way forever, and in the case of your mortgage, it’s common for your home loan to stray a bit from your financial goals and abilities over time. Luckily, homeowners often have many options at their disposal to help align their home loans with their wallets. 

‍

Two common solutions are replacing your existing loan with a new one (i.e. refinancing), or petitioning your lender to restructure your present loan (i.e., modifying your loan). Both of these options can be beneficial in different cases. We’ll help you decide whether a loan modification vs refinance is better for your situation. 

What is a loan modification?

A loan modification happens when your lender agrees to change one or more aspects of your mortgage in order to make your monthly payments more affordable. Lenders can tweak your monthly payment by pulling a few different levers:

• Lowering your interest rate
• Increasing your loan term length
• Lowering your outstanding principal balance
• Switching from an adjustable-rate mortgage to a fixed-rate mortgage

‍

Lenders don’t offer loan modifications to just anyone. Loan modifications are generally only available if you’re already behind on your mortgage payments, or at risk of delinquency. They’re often meant to deal with long-term financial setbacks, such as disabilities, career changes, or chronic illnesses. 

‍

In order to get a loan modification, you’ll need to approach your lender and enter into a loss mitigation program. These vary by lender – and not all lenders may be willing to work with you. If they are, you’ll generally need to submit letters and documentation proving your need for a loan modification. If your lender agrees, they’ll offer you new terms which you can decide whether to accept. 

Loan modification pros and cons

Pros

• Cheaper fees than refinancing
• Avoid foreclosure on the home
• Don’t need to apply for a new loan
• May be quicker and easier way to permanently reduce payment

‍

Cons

• Availability varies by lender
• Can lengthen your time in debt
• May increase long-term loan costs
• Need to demonstrate financial distress
• Generally only available for owner-occupied housing

‍

In addition, if your lender agrees to reduce your principal balance, there may be additional consequences. Reductions in principal balances may be recorded as a debt settlement, which may be taxed as income. This can also damage your credit score, although likely not as much as if you’d faced more serious consequences such as bankruptcy. 

What is a mortgage refinance?

A mortgage refinance, on the other hand, happens when you take things into your own hands and replace your current mortgage with a new one from another lender. Rather than changing up the details of your current loan, you swap it out for a new one. 

‍

Refinancing your mortgage can help you achieve several goals, depending on how your interest rate, loan term length, loan type (fixed-rate or adjustable-rate), loan amount, and borrowers change. People commonly refinance for a few different reasons:

• Lower your monthly payments
• Shorten your loan payoff period
• Save money on interest over the long term
• Reduce fluctuations in payment amount (as with an adjustable-rate loan)
• Remove or add borrowers to the loan (as in cases of marriage or divorce)
• Borrow against equity in the home (as with cash-out refinance mortgages)

Refinance pros and cons

Pros

• Access equity in your home
• Can help lower your monthly payment
• Eligibility not determined by financial hardship
• Can help you save a significant amount of money over time

‍

Cons

• Can extend your time in debt
• Takes several weeks to complete
• Requires good credit and income
• Expensive closing costs and fees
• Typically requires at least 20% equity in the home
• Reduced benefits during periods of high refinance rates

Refinance vs loan modification: Which is right for you?

In general, loan modification is geared more toward homeowners with fewer options to lower their payments, while refinancing can be used by more well-qualified homeowners to achieve a wider range of goals. To help ensure you know which one is appropriate for you, run through this list of questions before deciding on a refinance vs loan modification:

What are your goals?

Are you simply having a hard time making ends meet? Refinancing and loan modifications can help with that, but more broadly, refinancing can help with other financial goals as well. A cash-out refinance can help you tap into your home’s equity as a source of flexible funds, for example, while a simple rate-and-term refinance can help you save money on interest and pay off your loan sooner in some cases.

Does your current lender offer any support?

Before deciding on anything, it’s a good idea to see if your current lender can help you achieve your goals. If you’re dealing with a temporary challenge like a job loss, they may be able to offer a more appropriate solution such as loan forbearance. If you’re looking to refinance your mortgage, they may offer a better deal than other lenders in the interest of keeping you as a customer. 

Can you currently qualify for a new mortgage?

A big consideration is whether you would even be able to qualify for a new mortgage at all. Often, loan modification is reserved for people nearing default, or who have already defaulted. You may not even be eligible to refinance your loan in cases like this, since most lenders require you to be current on your mortgage. 

‍

The lowest interest rates (and, in turn, the lowest monthly payments) are generally offered to homeowners who already have excellent credit. If your credit score has increased since you first took out your loan, then you stand a better chance at qualifying for a lower rate. 

What sort of interest-rate environment are you in?

In addition to your own creditworthiness, it pays to pay attention to what’s going on with the broader economy as well. If interest rates as a whole have gone down since you first took out your mortgage, it may be easier to refinance for a lower rate and decrease your monthly payment. Conversely, if rates have gone up, it may be harder to find a lender offering lower rates than you’re already paying. 

Do you like your current lender?

Some people simply don’t like their current lender and are looking to divest from the relationship. It may not be wise to use it as the sole decision-making factor in the equation, but if you already have other reasons to consider jumping ship, it may be just enough of a nudge to push you into the “refinance” camp. 

Have you run the numbers to see how expensive it’ll be?

Any time you change your current mortgage — whether you’re opting for a loan modification vs refinance — it’s important to pay attention to a few things in particular:

• Term length: How much longer — or how much less time — will you be in debt?
• Monthly payment: How much higher — or how much lower — will your payment be?
• Total interest paid: How much more — or how much less — will you pay in interest over the life of your loan?

‍

Oftentimes, extending your loan term can help you lower your monthly payment, but at a much higher long-term cost since you’ll be paying interest for a longer period of time. You can run these numbers for yourself using a refinance loan calculator, which you can also use to see how much a loan modification may impact your overall costs. 

Final thoughts

In theory, choosing between a refinance vs loan modification should be easy: if you’re having trouble making your payments already, choose a loan modification. If not, choose a refinance. It’s not always that simple, however, and we’ve given you several factors to consider. 

‍

One final consideration, however, is your alternatives. Before you decide on whether a loan modification vs refinance is best for you, consider whether these options may be more appropriate under your circumstances:

• Credit counseling
• Home equity loan
• Mortgage loan recasting
• Home equity investment
• Mortgage loan forbearance
• Home equity line of credit (HELOC)
• Short sale or deed-in-lieu of foreclosure
• Repayment plan to catch up on overdue mortgage payments