Should You ‘Modify’ or ‘Refi’?
A quick note about interest rates before I jump into the main topic. The media and mass marketers continue to bombard consumers with claims of “historically” low rates, and it may feel like you are missing an opportunity if you haven’t refinanced your loan for the 3rd time in as many years. The fact is that the margin by which rates have been the “lowest” is very slim. In many cases you need at least a 1% drop in rate before it even makes financial sense to refinance, and even at that your payment may only be dropping $100 per month. That’s not an inconsequential amount, and you will recoup your closing costs in about 3 years, but I speak to many borrowers who have the perception that they can save hundreds of dollars every month by refinancing. The one opportunity I am seeing more is borrowers who have been paying on their 30 year mortgage for five or more years are now refinancing down to a 15 year loan to take advantage of the huge interest savings.
I am frequently asked by home owners if they should modify their mortgage or refinance their mortgage. Prior to 2008 loan modifications were virtually non-existent, but now the term has become so commonplace that it has confused borrowers into thinking it is a good thing to do.
A loan modification is a voluntary negotiation between yourself and your lender to alter the terms of your existing loan obligation. The goal of the modification is to lower the payment enough that you can afford to stay in the home. There are lots of ways lenders can get your payment lower and the most common is to lower the interest rate substantially either for a limited time period or permanently. Other methods include extending your loan term, or a principal reduction.
The drawbacks to a loan modification are that it is considered a derogatory credit issue, and you may end up paying more in the long run. While the process may seem friendly and with the lender’s cooperation, the fact is you have not paid back your loan under your original agreement. It’s impossible to say how this will impact your credit history as there are many other factors to consider, but I can tell you that from a mortgage lending perspective a loan modification is viewed as a significant derogatory item. There will be some sort of entry to your credit report indicating you have not paid as agreed or are paying under modified terms. Your credit score will drop and your ability to borrow in the near future may be impacted as well. In addition, sometimes the lender will add back all the deferred interest to the end of your loan so they still get all their money in the long run.
If you are truly facing a financial hardship and are at risk of losing your home then a loan modification is a fantastic option to pursue. The drawbacks I mentioned are a secondary concern if the modification keeps a roof over your head. It’s just important you understand the possible consequences.
Lacking a financial hardship, a refinance is the best option for reducing your payments. If you are calling your current lender about lowering your payments make sure you are clear about wanting a refinance and not a modification. I have spoken to a few clients who have been inadvertently sent to their lender’s loan modification department instead of the refinance department because the customer service person just heard “I want to modify my payment…” and didn’t ask any additional questions.
If you are unable to refinance your loan for some reason and have been denied the loan modification by your lender, try again. I spoke to one person who submitted their request three times before successfully being approved for the modification.
Michael has 21 years’ experience in the lending industry. In that time he’s directly helped over 1,400 families finance the purchase of a new home or refinance an existing loan. Rebecca has a CPA background in auditing financial institutions which brings an incredible resource to First Priority Financial. They are licensed to help families in the states of WA and CA. If you, or anyone you know, needs help with a home loan call 509-252-9151 or send an email to Mike Mullin