Many borrowers, faced with payments that are now, or soon will be out of reach for them are wondering what their options are. Refinancing and modifying their loan are two choices. Borrowers should look at both when determining their options, with refinancing being the preferred option.

There are differences between refinancing and getting a loan modification. Below are some comparisons and contrasts

Understanding the differences

A refinance replaces the existing mortgage with a new loan with a lower rate, and/or more favorable terms, such as a fixed rate loan versus an adjustable one. It is a more permanent solution than most loan modifications, and usually offers greater advantages.

A loan modification is an adjustment to the terms of the borrower’s existing loan, often for a short period of time to help the borrower get back on their financial feet, but the original loan is still in place. It’s the option borrowers tend to turn to if they cannot refinance their existing mortgage.

To qualify for a refinancing, borrowers need to have good credit. Credit report blemishes such as recent late mortgage payments (past 12-24 months) will disqualify most borrowers from being able to refinance, making them a better fit for a loan modification.

In the case of a refinance, borrowers can shop for different lenders and search for the best rates and terms. In a loan modification, the original lender is doing the modifying, and borrower would work only with them.

The process of refinancing is often very straightforward, with the borrower meeting with the lender perhaps only once or twice. The process normally takes 30-45 days. Loan modifications can take longer and can be more stressful. This is due in part to the volume of loan modifications that lenders are being asked to do.

On the other hand, lenders often charge fees for refinancing a mortgage, depending on the rate they are offering. Lenders may or may not charge fees for a loan modification. Missed payments and other fees can sometimes be bundled into the modification, so the borrower would need less money up front to complete a loan modification.

Challenges of refinancing

While refinancing is a great option for homeowners looking to reduce their mortgage payments, qualifying for one can present a number of challenges, often with issues related to home equity. Below are some of the things that make prevent a homeowner from obtaining a refinance and make them a more likely candidate for a loan modification.

Declining property values

Declining property values, as often happens in an economic downturn, can make it difficult to obtain a mortgage refinance, particularly if the mortgage balance exceeds what the property is now worth. A lender is not likely to be interested in refinancing a $240,000 mortgage on a $200,000 home. However, certain federal programs, such as Making Home Affordable or Help for Homeowners, offer incentives for lenders to mark down and refinance such “underwater” mortgages and may be helpful in the right circumstances here.

Second mortgages

Second mortgages present a unique challenge to borrowers who want to refinance, especially those with little or no equity in their homes. When the borrower acquired the second mortgage (either fixed term or some type of HELOC), the lender of that second mortgage agreed to take second position (in the event of default) to the lender of the first mortgage.

If a borrower wants to refinance the first mortgage, the lender of the second will have to give their consent before this can happen. Second mortgage lenders may be unwilling to do that, particularly in a weak housing market, preventing the refinance of the first.

Another option is to refinance both existing loans into one. If there is less than 20 percent equity in the property though, the lender will require mortgage insurance. This will add an additional expense each month, but depending on other factors, this option could still create a lower payment for the borrower.

Late payments

Borrowers who are looking to refinance due to a financial hardship may have trouble trying to qualify. As mentioned above, recent missed or late credit payments will likely disqualify most borrowers from the transaction, especially if it was on the mortgage they are seeking to refinance.

Decline or loss of income

Total loss of income would disqualify any borrower from refinancing their home. Partial loss of income may present challenges as well, if it puts the borrower’s expense-to-income ratio outside of the range the lender finds desirable.

Published on November 23, 2009