Loan Modification vs Refinance
A loan modification simply changes the terms of your existing home loan. Refinancing your mortgage involves paying off your existing loan in full with a new loan, typically from a different mortgage lender.
How Loan Modification Can Help
Loan modification programs can be broken down into four main categories, each with its own set of advantages and disadvantages. It’s also important to note that lenders are more likely to approve a loan modification program if you are behind on payment or your loan is underwater.
Reducing the Interest Rate of Your Loan
When interest rates fall after you’ve signed your existing mortgage, it may be possible to modify your loan to take advantage of the lower rates. Doing so can lower your monthly mortgage payments as well as the total cost of your loan.
Changing the Loan Term
Extending the term of a loan can prove advantages for individuals struggling to afford monthly payments on their loan. Unless combined with additional loan modifications, extending your term will result in a higher total cost of the loan. But because that cost is spread out over a longer term, monthly payments will decrease, which may be necessary to avoid foreclosure.
Changing the Structure of Your Loan
If your loan has an adjustable interest rate, it’s often beneficial to change it to a fixed-rate loan. Doing so will make your monthly payments more predictable. Plus it prevents your interest rates from rising over time, which would otherwise result in higher monthly payments and a higher total cost to repay the loan.
If you’re having trouble making payments on your loan, principal forbearance sets aside a portion of your principal to be paid at a later date. The forebeared portion of the loan is typically free from interest. However, the “balloon payment” for the forebeared portion is often rather sizable. So be sure to adjust your budget to ensure you’re able to pay it when the time comes.
How Refinancing Can Help
Refinancing a loan allows you to shop around for lenders and enter into a completely new loan with more advanced terms. Refinancing is typically advantageous if you are current with your payments and have at least some equity in your home. It may include any of the adjustments that are possible with a loan modification except for principal forbearance.
Other possible advantages include:
Shortening the Term of Your Loan
If you’re looking to pay your loan off sooner, you may want to shorten its term length. This will result in higher monthly payments. However, the shorter the term of a loan, the less time it will have to accrue interest. Shorter-term loans also tend to have lower interest rates.
A cash-out refinance involves taking out a loan for an amount than greater than the balance of your existing loan. In doing so, you would receive the difference between the existing and new loans in cash. This can be a good way to pay off other high-interest debts, such as credit card or medical debt.
Does a Loan Modification Affect Your Credit
It is possible that modifying your loan can negatively impact your credit score. However, late mortgage payments also negatively affect your credit. And foreclosures have an even more negative effect. With this in mind, loan modification should ultimately improve your credit score, even if it causes it to fall in the short term.
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