Loan modifications gained notoriety during the post- 2008 housing crisis but they aren’t just for homeowners who are facing a mortgage that is underwater. In fact, if you’re considering refinancing, you may want to explore the option of a loan modification instead.
What is the difference between a refinance and a loan modification?
When you refinance, you are replacing your existing mortgage with a new loan. This is done for a number of reasons, including taking advantage of a lower interest rate or to change your loan type (i.e. from a 7 year ARM to a 30 year mortgage). Your credit, equity and the type of loan desired are each taken into consideration and you will frequently have a new lender along with your new loan.
When you modify your loan, you revise the loan you already have rather than replacing it with an entirely new one. Although every lender varies as to whether they offer loan modifications, if yours does, it may be a viable option to reduce your interest rate and/or monthly payment.
Also called mortgage or debt modification, when a loan is modified, only a very specific aspect of that loan is revised, such as the interest rate. No other changes can be made; the majority of the loan stays intact.
Many lenders are open to loan modifications because it ensures they will retain their customers rather than potentially lose their business to another bank if they refinance.
If you need to add or remove a person from the mortgage, you must refinance your loan. This cannot be done with a loan modification.
What are the costs involved in each?
If you modify your current loan, you will pay a one-time fee that generally ranges between $1,200 and $2,500. Some modifications have no associated cots and there are no hidden fees.
As for refinancing, there are many loan options, some which involve no costs or points. If the loan is no cost and fees at closing are not paid by the lender, they will be rolled up as part of the loan or recouped via a slightly higher interest rate.
Making the Choice
Determining which loan option is best depends upon many unique variables and can be tricky. Some things to consider are:
- Does your lender offer a loan modification option?
- If so, which option is less expensive?
- What is your ‘breakeven’ point for both?
Some loan modifications offer teaser rates, which in the short term, will lower your monthly payments. But, because you are only paying interest, your loan principle will not be reduced and ultimately, you will end up paying more. This is definitely something to be aware of when choosing which route to take.
It is always best to consult with your lender or financial advisor to ensure you fully comprehend the pros and cons of each loan and which is the best option for your financial situation.