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If you’re having trouble making your mortgage payments, or want to take advantage of a lower interest rate, refinancing or loan modification can lessen the burden. Both of these methods can help lower your monthly payments — but it’s important to understand the advantages and disadvantages to each method. Once you know the differences, you’ll have a better idea of whether loan modification vs. refinance is right for your specific situation.

What is loan modification?

Loan modifications change the terms of a mortgage to lower the payments. If you’re experiencing a financial hardship that’s keeping you from paying your mortgage each month, you can use loan modification to avoid foreclosure.Ìý

You should contact your loan servicer to learn more about loan modification plans: they are the only ones who can modify the terms of your loans. For people with loans through Fannie Mae or Freddie Mac, the Flex Modification program can be helpful.Ìý

Borrowers must provide documentation of changes in their financial circumstances so the servicer can decide whether you’re eligible for a modification and how it can be modified. If your loan servicer deems you eligible for a loan modification, you might see changes like a loan type change, a loan term extension, decreased interest rate or reduction of the principal.Ìý

Reasons why you may get a loan modification

• Major illness that results in medical expenses or disability that affects your ability to pay your mortgage
• Job loss or reduction in income
• Death of a spouse or other income provider in your household
• Divorce or separation that has impacted your income or expenses
• Natural disasters or other unexpected expenses that have depleted your savings
• Inability to sell the property due to a depressed real estate market or negative equity.
• Military service that has affected your income or ability to pay your mortgage

It's important to note that the specific eligibility requirements for loan modification programs can vary depending on the lender and the type of loan you have.

What are the risks of loan modification?

A loan modification can negatively affect your credit score and may extend the length of your mortgage, which can increase your overall interest payments. Additionally, loan modification programs may have specific eligibility requirements, and there is no guarantee that your request will be approved.

What is a refinance?

Refinancing is different from loan modification in several key ways. When you refinance, your current mortgage is replaced with a new one — and the new loan can be refinanced with other lenders. You also don’t need to prove that you’re undergoing financial hardship. As long as you’re willing to prove that you can pay back the loan, you’re free to refinance for whatever reason you choose — unless you have an FHA or VA loan. (Learn more about your options for refinancing a VA loan here.)

Lower interest rates and/or lower monthly payments are a common reason borrowers choose to refinance. However, some borrowers hope to shorten the loan term in an effort to pay it off faster — which will make monthly payments go up.

Refinancing allows borrowers to find the best terms on their own. When you refinance your loan, the lender pays off your existing mortgage; you’re then responsible for the loan with the new lender.Ìý

→ Learn how soon you can refinance your mortgage

5 differences between loan modification vs. refinance

There are five major differences between loan modification and refinancing your mortgage:

1. Opportunity vs. necessity

When you refinance your mortgage, it’s voluntary. You’re welcome to continue paying your original mortgage loan until the term has ended — a lender cannot require you to refinance. Most people choose refinancing because of a good opportunity: whether that’s to lower your monthly payments, pay off the loan faster, to take advantage of a better interest rate, or other beneficial reasons.

Meanwhile, loan modification happens out of necessity. Borrowers choose modification in order to avoid foreclosure, and the financial hardship requirement limits this option to people who truly need assistance.

2. Loan term changes: shorter vs. longer

Generally, loan modifications lengthen the term of your loan. Your mortgage term might be extended from 30 to 40 years, in order to lower the payments and give you more time to pay it off. Essentially, you’re adding more years to your mortgage term as a way to lower the month-over-month financial burden.Ìý

In contrast, refinancing can shorten the terms, if you so choose. For example, if you have 15 years left on your mortgage, you might want to apply for a 10-year loan to speed up the process. Your monthly payments will go up, but you’ll save money in interest expense over the remaining term of your loan.Ìý

3. Interest rate change

Both loan modification and refinancing can lower your interest rate, but it’s not guaranteed with loan modification. While borrowers can refinance at will, especially if they see competitive interest rates, loan modification is up to the servicer. They will determine the best way to lower your monthly payments. You may see an interest rate change, but it’s not guaranteed.

→ Find out what affects mortgage rates

4. Loan structure change

Both loan modification and refinancing can affect your loan structure, but with loan modification, that choice isn’t necessarily up to you. For example, you may have taken out an adjustable-rate mortgage (ARM), but your loan servicer may change you over to a fixed-rate loan at their discretion; the choice won’t be yours.

Because refinancing allows you to choose the specific loan you want, you can also change the way your new loan is structured — but you don’t have to.Ìý

5. Principal forbearance

Finally, loan modification may include principal forbearance. Principal forbearance is when a lender agrees to take part of the unpaid debt to add to the end of the loan as a balloon payment. The borrower is still liable for this debt, and it’s due at the end of the payoff period — but it’s not due immediately.

With refinancing, principal forbearance usually isn’t necessary, since you’ll need to be current on your loans to be eligible. There’s really no need for forbearance — especially if you’re refinancing to shorten the term of your loan and can handle the larger payment each month.Ìý

When should you refinance vs. modify your loan?

If you're struggling with mortgage payments, it can be difficult to know whether refinancing or loan modification is the best solution. Both options can help lower your monthly payments, but they work in different ways and are appropriate for different situations.

The determining factor in loan modification vs. refinance is whether you’re behind on your payments and in danger of foreclosure.Ìý

• If you’re current on payments, only refinancing is available.Ìý
• If you’re behind on payments, loan modification is usually your only option.

Can you refinance after a loan modification?

You can refinance after loan modification, but there’s usually a 12 to 24-month waiting period after the modification has been approved. Generally, to be approved for refinancing, you’ll need a stable income and total monthly expenses cannot be more than 40 percent of your gross monthly income.

Is it time to take a second look at your loan?

Choosing between loan modification vs. refinance is an easy choice if you’re behind on your payments. When you’re current, however, it’s still worth taking an occasional second look at your mortgage. You may get better terms, free up some extra cash each month, or pay off your mortgage faster.Ìý

While these two financial options offer different pros and cons, both can be extremely useful for homeowners. Always research your options and find the right solution for your needs.

FAQs

Here are answers to more questions about loan refinances and modifications.

Q: Can I refinance or modify my loan if I have bad credit?

A: It may be more difficult to refinance or modify your loan if you have bad credit, but it's not impossible. You may need to work with a specialized lender or explore alternative options like FHA loans or VA loans.

Q: Can I refinance or modify my loan multiple times?

A: Yes, it's possible to refinance or modify your loan multiple times, but it may not always be the best option. Each time you refinance or modify your loan, you may incur additional costs and fees, which can add up over time.

Q: Is a loan modification a good idea?

A: Loan modifications can be a good idea if you're struggling to make your mortgage payments and are at risk of foreclosure. It can help make your payments more affordable and keep you in your home. However, it's important to weigh the potential benefits and drawbacks of a loan modification before pursuing it.

Q: Does a loan modification hurt your credit?

A: Loan modifications can have a negative impact on your credit score, but the extent of the impact will depend on your individual circumstances. Late or missed mortgage payments can hurt your credit score before a loan modification, and any missed payments during the loan modification process can also have a negative impact. However, if you make your modified payments on time and in full, your credit score may start to recover over time.