It’s only natural for homeowners to find ways to lower their existing monthly payments and make them affordable. There are mainly two options for that: a refinance and a modification. Each is a distinct process with its considerations and challenges. How do you know which option is viable? Find out below.
First, let’s define refinance and modification.
If qualification is essential to any refinance application, financial hardship is a requirement for any loan modification.
Refinance is taking out a new loan to replace the old one. Being a new mortgage, it comes with a new set of terms that are most likely favorable to you as you have desired them to be, e.g. a lower rate, a longer/shorter term, a more stable product.
On the other hand, modification is adjusting certain terms of your existing loan so you can continue paying and thus stay in your home. Modification is an option for those who are struggling with their mortgages and may have missed a payment or so.
The Key Elements of a Refinance
You don’t really have to refinance with your current lender as you can look around first and find the mortgage loan of your choice from various lenders.
To qualify for a refi, your credit score, your income, and your mortgage if you remain current, and to some extent, your other debts will be looked into. Your credit is especially important if you’re vying for a lower rate.
If you’ve have been delinquent on your debts, especially your mortgage, it will reflect on your credit report which is the basis of your credit score. Another serious implication of missing mortgage payments is that lenders can turn down your application.
The lender will order another appraisal on your home whose value should exceed your loan balance. Lenders usually look for at least 20% in equity in the home for a refinance, although they may allow something below that subject to a mortgage insurance.
Homeowners with second mortgages such as home equity lines of credit might be left with little equity and can try to combine their first and second mortgages as an option.
When you refinance, expect to pay for the new appraisal, credit check, and other costs toward originating and underwriting the new mortgage. These closing costs can be wrapped into the loan or paid upfront.
Modification: An Option When You Can’t Refinance
It’s a tool that allows homeowners to be current on their mortgage again, something that a refinance requires beforehand. A loan modification is targeted to borrowers who are experiencing financial hardship and can’t afford their current mortgage payments before long.
If you owe more than your home’s value, you could also seek to adjust your mortgage terms. But this should not be the sole reason behind the modification.
Before any term is modified, the lender will examine if you have a “documentable hardship”, e.g. job loss, reduced income, and costly medical treatment. Your income and financial affairs should prove this hardship that as a result you are unable to make your mortgage payments on time and will likely continue to do so unless the terms are changed for the better.
You can request for a lower rate, extend the term, or forgiveness of the loan principal. If the lender finds you eligible, you will be subjected to a trial period to see if you can pay your adjusted monthly payment. If all goes well, you’ll be given a permanent modification.
Other than that, no strict qualification process such as credit check is required. The lender can charge a modification fee that it can roll into the modified loan.
HAMP® is a perfect example of a loan modification program backed by the government. Although it will expire later this year, Freddie Mac and Fannie Mae have replacement programs for HAMP® starting October 2017. Watch out for that.