With the ongoing foreclosure crisis, there's been a lot of talk about loan modifications and refinancing mortgages as ways of helping at-risk borrowers stay in their homes. Together, they're the twin pillars of the Obama Administration's Making Home Affordable (MHA) program. But there's still a fair amount of confusion among consumers about the differences between the two and what they both involve.

Both loan modifications and refinancing a mortgage are ways of reducing mortgage payments to make them more affordable. But with one key difference. In a loan medication, the terms of the existing mortgage are altered to make the mortgage more affordable. In a refinance, an entirely new mortgage with a lower interest rate is issued to replace the current one.

Loan Modification May Be Easier for Some

Both approaches have their advantages. Refinancing a mortgage is seen as the more secure, permanent solution since you can lock in the new rate for the life of the loan. Loan modifications may offer only temporary relief - modified mortgages often revert to their original terms after a certain period of time. But a refinance requires good credit and loan modifications are often easier to obtain, particularly for persons in financial difficulty.

The early results from the Making Home Affordable program seem to bear this out. Administration officials recently indicated that 200,000 trial loan modifications have been approved under the program to date, compared to 80,000 refinances.

Requirements for MHA refinance

To qualify for an MHA refinance, homeowners must have a mortgage that is owned or guaranteed by government-backed lenders Fannie Mae or Freddie Mac, which is the case for most U.S. home mortgages. They also must be current on their mortgage payments and have a mortgage balance no higher than 105 percent of the current market value of their home.

That 105 percent limit has been a barrier for many homeowners, given the sharp declines in real estate values since last fall, and administration officials have discussed raising it. However, that limit doesn't apply to MHA loan modifications, nor does the requirement that the mortgage be backed by Fannie or Freddie. To qualify for an MHA loan modification, homeowners need to have trouble making their mortgage payments, though they do not necessarily have to be behind on them.

Reduced interest rate on MHA modifications

One of the nice things about an MHA loan modification is that, unlike nearly all private loan modifications, it lowers the interest rate, albeit temporarily. The government provides lenders incentives to lower the interest rate to a point where the monthly mortgage payments do not exceed 31 percent of the homeowner's income, which may be lower than one can accomplish through refinancing. However, after five years the rate can start to go gradually go back up again to a predetermined ceiling.

The Making Home Affordable loan modifications and refinances are certainly not the only options available to homeowners under financial stress. Virtually all banks and other mortgage lender have their own refinance and loan modification programs, which borrowers may be able to obtain more quickly than going the government-backed route. However, the features of the MHA plans are attractive enough that most borrowers will at least want to consider them before exploring other options.

For more information, visit the Making Home Affordable Plan web site.

Published on June 23, 2009