You are in a difficult place, with the threat of losing your home. This idea is truly worrying, and others have felt the same way. Individuals who own a house can decide to refinance their mortgage or apply for a loan modification.
While finding a solution to foreclosure, you can use these options, which are not identical, but each offers differing advantages and disadvantages. In order to decide how to proceed in your situation, we need to keep things as clear as possible.
Refinance or Loan Modification: Which Way to Go?
You are driving along when you hit a bumpy stretch of road. Your vehicle is stalling, and you are afraid you will break down. Here, your car is your home loan, and that bad period is a financial problem that is causing difficulties in paying your mortgage.
Your two key mechanics are able to assist: one is a full engine overhaul (refinancing), and the other is a band-aid that puts you back on the road (loan modification). Let us take a look at what you can do with each of these “mechanics.”
The Engine Overhaul: Refinancing Your Mortgage
You can think of refinancing as receiving a whole new mortgage loan to pay off your original loan. It is similar to replacing your old car with a new one that is more efficient. Refinancing means you are, in effect, taking out a whole new loan, sometimes with a different interest rate, a new loan duration, and even a different lender.
When Refinancing Could Be an Excellent Choice:
- Lower Interest Rates: If you purchased your house when interest rates were high, and interest rates have fallen considerably now, refinancing could be an excellent option to reduce your monthly payments. Even a slight reduction in your interest rate can save you a considerable amount of money throughout the duration of your loan.
- Improved Loan Terms: Perhaps you wish to transition from an adjustable-rate mortgage (ARM), where you have a variable interest rate, to a fixed-rate mortgage. Refinancing enables this, providing you with fixed monthly payments. You might opt for a short loan term to pay off your home sooner, or a long loan term to lower your monthly payments, depending on your objectives.
- Tapping Home Equity: If you have accumulated considerable equity in your home, you may be able to make a “cash-out refinance.” It means you pay out more than what you still owe and get the extra cashback. Often, people choose to borrow money for house remodeling, paying off debt, or facing urgent financial concerns. Be careful not to borrow more than you can handle because the bank has a claim on your property.
- Better Credit Score: If your credit score has improved dramatically since you initially borrowed money on your mortgage, you may be eligible for much lower interest rates today. This can be a big impetus to refinance.
The Temporary Solution: Loan Modification
We should now cover the subject of loan modification. Loan modification allows you to adjust the terms of your current loan rather than getting a brand-new loan. It is meant to aid homeowners who have difficulties making their existing mortgage payments. It works like an individual payment plan planned with the lender you currently have.
When Loan Modification Might Be Your Lifeline:
- Lower Interest Rates: This is where loan modification can truly excel. In contrast to refinancing, which is based on market rates, a loan modification can sometimes significantly lower your interest rate, even down to 2% in certain situations! This extreme reduction can make your monthly payments much more affordable.
- Extended Loan Term: Your bank may also consider extending the duration of your loan, say from 30 years to 40 years. Though you will be paying for a longer period, this distributes your payments and reduces your monthly requirement.
- Decreased Principal Balance: In extremely specific and critical situations, a lender may even forgive a bit of your principal balance. This is relatively uncommon, but it is an example of how adaptable loan adjustments can be under some circumstances.
- Easier Qualification: This is a huge difference from refinancing. For a loan modification, the primary concern of lenders is often your ability to make the new payments. They want to see that your mortgage payment would not exceed 31% of your gross monthly income after the modification. While they will consider other obligations, the focus is more on your ability to pay forward. This can be a lifesaver if your credit isn’t perfect.
- No Closing Costs: Unlike refinancing, loan modifications typically do not involve hefty closing costs. This can be a significant advantage if you are already facing financial strain.
Making Your Choice: A Step-by-Step Approach
This is not a decision to be rushed. It is a huge financial choice that will impact your future. Here is how to approach it:
1. Assess Your Financial Situation Honestly:
- What is your current income? Is it stable?
- What are you paying each month currently? Be frank about where your money is spent.
- Why are you having issues paying your mortgage? Is it a short-term bump or a permanent adjustment to your income or expenses?
- What does your credit score look like? Pull a free credit report in order to know where you stand now.
- How much is your equity in your house? This is how much your house is currently worth minus how much you still owe on your mortgage.
2. Know Your Objectives:
- Are you mainly looking to reduce your monthly payments so you can remain in your house?
- Are you looking to access lower interest rates and pay off your house in a shorter period of time?
- Do you have other financial requirements that you need from your house’s equity?
- Is rebuilding your credit a high priority?
3. Research Both Options Carefully:
- For Refinancing: Phone a few lenders (banks, credit unions, mortgage brokers) to obtain quotes. Compare interest rates, loan lengths, and all relevant closing costs. Inquire about various types of loans that can be made available (fixed-rate, adjustable-rate, etc.).
- For Loan Modification: Reach out to your existing mortgage lender directly. Inquire about their loan modification programs and what you will need to document. Feel free to ask pointed questions regarding any interest rates, terms of the loan, and fees. Research government-sponsored programs such as the Home Affordable Modification Program (HAMP), if still available, or similar programs.
4. Make a “Pros and Cons” List for Each Option
- Refinancing Advantages: Lower interest rate (market-driven), new terms on loan, ability to cash out, ability to build credit in the long run if payments are made timely.
- Refinancing Disadvantages: Needs good credit, closing fees, not always a viable option if in extreme financial hardship.
- Loan Modification Advantages: Possibly extremely low interest rates, longer terms, easier to qualify if experiencing hardship, and no closing fees (typically).
- Loan Modification Cons: Less equity accumulation, usually for those in serious financial difficulty, potentially temporary credit effect, and the process is often complicated.
5. Consider Professional Advice:
- Housing Counselors: Non-profit housing counseling agencies are available to give free or low-cost guidance on refinancing as well as loan modification. They can assist you in determining your choices and guide you through the process. Seek HUD-approved counselors.
- Financial Advisors: A financial advisor can assist you in reviewing your overall financial situation and in deciding what option best suits your long-term objectives.
6. Do not Rush It!
This is not a quick decision. Take your time, get all the facts, and consider everything patiently. The more you know, the better decisions you will make about your financial future.
Conclusion
Keep in mind that both refinancing and loan modification are intended to assist you in not losing your home to foreclosure, but instead getting back on stable financial footing. The “correct” decision hinges solely on your unique situation.
By knowing the subtleties of both choices and taking the time and effort to learn and compare, you can make an informed choice that best serves your situation and allows you to keep your house for the long term.
