Loan Modification vs. Refinancing: Which Should I Use?

It's more than just lowering your monthly payments

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Loan modification and refinance might provide similar outcomes—lowering your monthly bill and/or your mortgage interest rate—but they are designed for two different types of homeowners. The main difference is that loan modification simply restructures the terms of an existing loan for someone struggling to pay bills, while a refinance is a new mortgage with more favorable terms that pays off your current loan. As such, there are very different qualifications, as well as pros and cons, for each.

Learn more about loan modification versus refinancing to find out which financing tool might be best for you.

Key Takeaways

  • If you’re trying to lower your monthly mortgage payment, two of the tools available to you are loan modification and refinancing. 
  • A loan modification restructures the terms of your existing loan, while a refinance is a new loan that pays off your current mortgage and includes better terms.
  • Loan modification is designed for people who are struggling with their current mortgage payments.
  • Refinancing is geared toward helping homeowners with strong credit and payment histories move into a more favorable home loan.

What’s the Difference Between Loan Modification and Refinancing? 

  Loan Modification Refinancing
What Happens Keep the current loan, but with changes in terms (interest, duration, etc.) Pay off existing loan and begin a new mortgage
Eligibility Must demonstrate financial hardship or, in some cases, be behind in mortgage payments Payment history and credit must be in good standing
Must have ample equity in the home
Application Process Work directly with lender; must demonstrate financial hardship and share financial information Must have ample home equity (verified through appraisal), and meet credit and income requirements 
Potential Benefits Avoid foreclosure; lower interest rate and/or monthly payment New loan with a lower interest rate, shorter term, or a different type of loan (e.g., trade ARM for fixed rate)
Drawbacks Increase in overall loan cost; credit score may drop Closing costs; more-stringent qualifications

What Happens: Loan Modification vs. Refinance

The biggest difference between these two options is that loan modification restructures the current loan, while refinance puts you into a new home loan. 

Eligibility: Loan Modification vs. Refinance 

In general, loan modification is for borrowers who are in the midst of a financial struggle, while refinancing is for borrowers who are in solid financial shape but want a different home loan that benefits them in some way.

To be eligible for a loan modification, most lenders will require that you explain your financial hardship and provide documentation. Some might not consider modifying your loan unless you’ve missed payments already. If you have a government-backed loan, there may also be special loan modification programs available. It’s always best to call your lender to ask about how you might qualify for loan modification.

Refinance applicants must have ample equity in the home (and will have to prove it with an appraisal), as well as meet all the lender’s requirements, including for credit history, debt-to-income (DTI) ratio, and other criteria. 

Potential Benefits: Loan Modification vs. Refinance

The key reasons to seek a loan modification are to avoid foreclosure or having to claim bankruptcy. Each type of loan modification—whether it’s lowering your principal balance, extending your loan term, lowering your interest rate, or switching to a fixed interest rate—is designed to ease your burden by lowering your monthly payment amount. 

With a refinance, though lowering the interest rate and having a lower monthly payment is usually the main driver, some people may also want to shorten their loan term or to move from an adjustable-rate mortgage (ARM) to a more predictable fixed-rate mortgage or from a Federal Housing Administration (FHA) loan, which requires paying mortgage insurance, to a conventional loan.

Drawbacks: Loan Modification vs. Refinance

With a loan modification, you have to be in financial peril to qualify. While you wait for approval, you may miss payments, which can hurt your credit score. And even when you are approved, it might be reported as a settlement, resulting in another credit ding.

A loan modification will usually cost you more over the life of the loan, especially if you’re extending the loan term.

With a refinance, the main downsides are that you have to go through a thorough application process (similar to when you bought your home) and pay full closing costs. If you don’t have good credit or steady income (the process may be more challenging if you are self-employed, for example), it might be more difficult to qualify. 

Special Considerations

In addition to traditional loan modification and refinance programs, there could be some special programs to consider, depending on your circumstances.

For instance, while a regular refinance requires you to have enough equity in the home, there have been some special refinancing programs designed specifically for homeowners with “underwater” mortgages, meaning they owe more than the home is worth. 

Likewise, you could consider modifying your existing loan on a temporary basis if you don’t want to go through a full-fledged loan modification. In fact, it’s often easier to get help on a temporary basis by requesting forbearance, which is when the lender agrees to either lower your payments or skip payments for a set amount of time. 

Which Is Right for Me?

Ultimately, your personal financial situation will dictate if you’re better off applying for a loan modification or a refinance.

Refinancing may be right for you if you…

  • Have good credit and are current on all of your payments
  • Think you can qualify for a lower interest rate than you currently have
  • Want a lower interest rate, a shorter loan term, or a different type of loan program
  • Plan to remain in the home long enough to recoup the closing costs

Loan modification may be right for you if you…

  • Can’t qualify for a refinance
  • Are struggling with your mortgage payments, have missed some, or anticipate that you won’t be able to pay in the near future
  • Can demonstrate that you’ll be able to afford the lower payment amount

Choosing between a loan modification and a refinance really comes down to asking yourself the following questions:

  • Are your finances strong or are you faltering?
  • Do you have a solid payment history and credit score?
  • Have you weighed the short-term benefits against the long-term impact of changing your loan terms or refinancing? (A loan amortization calculator can help with that.) 
  • Will there be any out-of-pocket costs involved?

To help you see how different scenarios, interest rates, and loan terms might play out, use a mortgage calculator to crunch some numbers.

The Bottom Line

While loan modifications and refinances have some similarities, they are very different programs for different financial situations. By assessing your financial situation and determining what your goals are, you can determine which is worth pursuing.

Frequently Asked Questions (FAQs)

Can you refinance after a loan modification?

There is nothing stopping you from refinancing after a loan modification, though some lenders may require you to wait a certain amount of time before you do. But keep in mind, if you had financial struggles that made you eligible for a loan modification, there’s a good chance that you wouldn’t meet the borrower qualifications of a refinance right away.

What happens after a loan modification is approved?

If you are approved for a loan modification, you’ll have to make a few on-time payments as part of a “trial period plan.” Once you do, the lender can then extend the modification agreement for the full life of the loan.

What are your options when a loan modification is denied?

If your lender denies your loan modification application, you can try appealing it. It must be done within 14 days after the servicer denies your application, and the lender has an additional 30 days to review your appeal. If you are still denied at that point, and having trouble making your bills, you can consider other options like forbearance or bankruptcy

How much does refinancing cost?

The cost of a refinance depends on the size and type of loan as well as your state and county; the average closing costs are approximately $5,000.

Can you reduce monthly mortgage payments without refinancing?

You may be able to reduce your monthly mortgage payment without a refinance if you qualify for loan modification. If you are paying private mortgage insurance (PMI), qualifying for it to be removed because of an increase in home value is another way to cut your payment. If your homeowner’s insurance is bundled into your monthly payment, finding a less expensive carrier could also help you save.