If you’re feeling financially stressed or missing mortgage payments, it can be confusing to know whether you need to do a refinance or a loan modification.
When searching for information about your options, you will hear these words used interchangeably but they aren’t really referencing the same thing.
Technically, a loan modification is a type of refinance as it restructures your original loan. However, a refinance usually refers to the type of restructuring for people who are NOT in default on their mortgage.
A loan modification is typically used for people who have defaulted on their mortgage. They are looking to resume regular payments but they don’t have the ability to immediately pay back the missed payments.
A typical refinance refers to the restructuring of a mortgage loan that is NOT in default
A refinance is usually appropriate for:
- A homeowner who has been making payments on the mortgage with no recent periods of default
- A homeowner who has a solid payment history showing months of on-time mortgage payments
- A homeowner who doesn’t have other outstanding, unpaid debt
If you meet the above criteria – a refinance may be a good option for you!
Your next step would be to find a new lender to “refinance” your mortgage. The new lender will pay off your existing mortgage and then give you a new mortgage with better terms.
Below are some reasons why someone would want to refinance their mortgage:
- To receive a better (lower) interest rate
- To change the duration of the mortgage (either get it paid off in a faster amount of time or extend the maturity out to lower the monthly payments)
- To eliminate bad terms that were included with your original documents
- To pull some equity out of your home
If you’re considering a refinance of your home, make sure you speak to a few different lenders so that you can compare what they’re offering so you get the best terms.
A loan modification refers to the restructuring of a mortgage loan when the loan is in default
A loan modification is different from a refinance because:
- Your lender doesn’t change: The new loan agreement is written for you by the same lender you’ve been making mortgage payments to. The investor on your original mortgage is the same investor that gives final approval on your modification – you don’t go to a new lender to execute the loan modification. If you have a government backed investor to start with (Fannie Mae, Freddie Mac, VA, FHA, or USDA) – they will be the investor that gives approval for you to execute a loan modification.
- The documents needed to apply are different: The application requires loan modification documents and a loan modification application.
- You don’t have to have made a recent mortgage payment to apply: You don’t have to show a perfect, on-time payment history in order to be approved. Loan modifications are designed for people who have experienced financial hardship and have missed payments. Your lender knows that you’re behind on your mortgage payments.
- You don’t have to show a perfect or “good” credit score in order to be approved: Since you’re missing mortgage payments and your lender is likely the one reporting the delinquent payments against you that impacts your credit score, you can get a loan modification even if your credit score isn’t perfect.
- It is possible to get a loan modification even if you have other outstanding, unpaid debt: If you’ve been through a period of financial hardship, it is common for you to be in the process of resolving other debt. Having other outstanding debt doesn’t necessarily prevent you from getting a loan modification.
If you are in default on your mortgage and ultimately want to refinance, you need to do a loan modification first
If your financial hardship has recovered but you are in default on your mortgage, you need to “bring the loan current” via a loan modification before you can complete a refinance.
The loan modification is the tool that allows you to bring the loan current and resume regular mortgage payments.
Most people can start the refinancing process six months or so after a loan modification.
Typically, you need to wait a few months following a loan modification so that you can build a stable payment history before you refinance.
For more information about how long you need to wait to complete a refinance following a loan modification, you can ask the new lender that you’re considering refinancing with. They will tell you the average timeframe that you need to wait (while making your mortgage payments) before you can refinance.
If you are on a COVID-19 Forbearance plan, you need to transition off of the plan and get current before completing a refinance
If you went on a COVID Forbearance plan and are now wanting to refinance, you need to go through the middle step of transitioning off of your forbearance plan to bring the loan current before you can complete a refinance.
Unless you can pay back all payments you missed during the forbearance period at one time (most people can’t), you will need to take advantage of one of the COVID-19 transition options.
The options that are available to you vary depending on who your investor is but you may be able to get on a streamlined deferral, partial claim or loan modification program to resolve the default.
Then, once the default is resolved – you can apply for a refinance.
Essentially, it is uncommon for a new lender to agree to refinance while you are on an active forbearance so you need to get into an agreement which allows you to resume making payments first and then look at refinancing.
If you are a homeowner in Washington state and have questions about whether a loan modification is the right next step for you, feel free to call me at (425) 654-1674.
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