The Bankrate promise
At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here's an explanation for .
A loan modification and a mortgage refinance aim for the same goal — to save you money by lowering your monthly payments. However, when it comes to which option you should choose, keep in mind that these two tactics and their use cases are quite different. To help you explore mortgage modification vs. refinance, let’s look at these two options.
Loan modification vs. refinance
A refinance is something you choose to do — if you don’t refi, the consequences are minor. You might miss out on some savings, but you won’t lose your house. A loan modification, on the other hand, is a loss mitigation option you might need to do if you are struggling to make mortgage payments. Without a loan modification, you risk going into default and losing your home to foreclosure.
To qualify for a loan modification, you’ll need to be behind on your payments or about to miss a payment, and you’ll need to document an economic hardship. To qualify for a refinance, you’ll need to be current on your mortgage payments and prove that you make enough money to absorb the new payments.
When loan modifications make sense
If you have not been able to stay current on your mortgage payments, a loan modification could make sense, provided you can get approval from your lender. Modifications are attractive to struggling borrowers because they don’t require a high credit score or proof of income. This option is designed to keep borrowers out of foreclosure, something that benefits the lender, too, since foreclosures are a costly headache for all parties involved.
Usually, loan modifications provide immediate mortgage relief, whereas refinancing can take 30 days or more. Borrowers can’t access cash via loan modifications (like in a cash-out refinance), but a loan modification doesn’t prevent homeowners from selling their homes.
How loan modification works
When you first compare loan modification vs. refinance, they can look similar because they both alter the original mortgage terms. With loan modification, though, those changes focus on helping borrowers dealing with economic hardship afford their mortgage payments.
To achieve that goal, lenders can reduce the interest rate, extend the term or change the loan type (or do a combination of all three). Some possibilities include:
- Longer loan term: If your monthly payment is too much, your lender might extend your term — from 15 years to 30 years, or from 30 years to 40 years. This gives you more time to repay your loan and reduces the amount of your monthly payment.
- Lower interest rate: If interest rates are lower now than when you locked in your mortgage, you might be able to modify your loan and get a lower rate. This step lowers your monthly payment.
- Different loan type: Perhaps your original loan was an adjustable-rate mortgage and you’ve felt the pinch of rising interest rates. The modification could switch that loan to a fixed-rate mortgage.
Pros and cons of loan modification
Pros of loan modification
- Lower monthly payments: By extending the loan term or lowering your interest rate, you could owe lower monthly mortgage payments.
- Avoid default and foreclosure: Agreeing to loan modification can help you avoid losing your house from missing mortgage payments.
- Keep the same loan with new terms: This is a big difference between loan modification and refinance. With modification, you keep the loan rather than swapping it out for a new one. This helps you avoid paying closing costs for initiating a new loan.
Cons of loan modification
- Must show hardship: Lenders will only explore this option with you if you can show proof of financial hardship, such as job loss or divorce.
- Your credit score might take a hit: Lenders might not offer loan modification until borrowers have missed payments, something that dips your credit score.
- Negotiating with lenders can be a cumbersome process: Lenders aren’t required to accept your loan modification application. Be ready for some potentially time-intensive processes to find a solution that works for you and your lender.
- Waiting period to refinance: Some lenders institute a waiting period. If yours does, you’ll need to get through it before you can explore a refinance after loan modification.
How to modify your loan
Each lender has its own rules and requirements for loan modifications. Most require you to provide documentation, including a hardship letter, bank statements, tax returns and proof of income.
If you’re struggling to make your payments and you think you qualify for a modification, contact your lender and ask how to apply. Lenders aren’t required to accept your application, and your lender might reject your request. In that case, you still might be eligible for a refinance.
When refinancing makes sense
If you’re up-to-date on your mortgage payments, refinancing might make sense.
One significant difference between loan modification and refinance is that a modification adjusts your current loan. Refinancing, on the other hand, replaces your existing loan with a new one. Additionally, loan modifications come with modest charges, typically a small administration fee. A refi is a new loan, so it comes with hefty closing costs.
Reasons it can make sense to refinance include:
- You could get a lower interest rate. The classic reason to refi is to lower your mortgage interest rate. However, your situation may not yield such dramatic savings, so be sure to calculate your break-even point — the amount of time you’ll need to make up the closing costs through lower monthly payments.
- You’re renovating your house. If it’s time to update your kitchen, upgrade your bathrooms or otherwise modernize your house, mortgage money is the cheapest financing available. A cash-out refinance lets you tap into home equity to pay for construction. This makes the most sense if you have plenty of equity, and if the renovations will add to the resale value of your home.
- You have an FHA loan. Borrowers who took Federal Housing Administration (FHA) loans can be especially good candidates for refinancing. That’s because FHA loans include steep mortgage insurance premiums that don’t go away over the life of the loan. The mortgage insurance premium on an FHA loan is between 0.45–1.05 percent per year, depending on your loan size and how much you put down. Eliminating that monthly fee could make refinancing into a conventional loan without mortgage insurance a good move.
Pros and cons of refinancing
Pros of refinancing
- Lower interest rate: This has been a huge driver of refinances over the years. That said, with rates at historic highs right now, you may want to wait if this is your main reason to refi.
- You can pull cash out: If you choose a cash-out refinance, you can turn some of your equity in your house into liquid capital that you can use however you want.
- You can switch terms: You might refi into a loan with a shorter term so you can pay down your mortgage faster. Or you might refinance an adjustable-rate loan to a fixed-rate one to avoid paying more if rates continue to climb.
Cons of refinancing
- You’ll need solid credit and income: The underwriting process for a refinance is not unlike the one to get your first mortgage. Lenders want to see you’re in good financial standing before they issue you a new loan.
- Closing costs are steep: Expect to pay thousands of dollars to refinance your mortgage.
- You could reset the clock on your debt: When you refi, you’ll have the option to choose the new loan term. Say you’re five years into a 30-year mortgage. While refinancing to a new 30-year loan could lower your monthly payments, it means you’re looking at day one of a new three-decade loan.
How to refinance your loan
Refinancing is essentially shopping for a new loan. Contact several lenders — comparing three or more offers can save you thousands of dollars over the life of your loan.
When you find an offer you like, you’ll have to provide the same documentation you submitted when taking the original loan: usually, bank statements, pay stubs and tax returns. You might need an appraisal, and you’ll need to pay for title insurance. The process can take up to two months.