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Modify or refinance? What should you do to your loan?


Modify or refinance? What should you do to your loan?

Sometimes mortgage payments become too heavy to roll.

When you first took out this loan, you didn’t figure out you will land into a situation, when these monthly payments would need a bit modification to fit into your budget.

So what are the options you’ve got?

Should you have a talk with your lender and go for a loan modification or consider mortgage refinancing?

Let's get straight to the point.

What is loan modification?

In loan modification, you make changes to your existing loan profile.

Say, due to some financial setbacks or hardships, your monthly payments are getting hampered.

So, you and your lender sit down to find a suitable solution.

The lender will consider a couple of factors before both of you come to a preferred payment structure:

  1. A financial hardship statement that will state your cause of default on your present monthly payments.
  2. Your current proof of income needs to be shown.
  3. A tax return form, in your case Form 1040 must be delivered.

After you provide the lender with all the above-mentioned information and documents, the lender will choose to do a few of these, or all of them, based on what is most comfortable for both of you:

  1. Increase the length of the loan, i.e stretching the loan term.
  2. Change the interest rate, i.e decrease the rate for a more suitable payment.
  3. If possible, a forbearance agreement might be issued if you become temporarily inactive in your monthly payments, to avoid foreclosure.

***But remember, if the lender finds foreclosure a more profitable option than offering a loan modification, then you are ditched. So, you can take help of attorneys while opting for a loan modification program. However, you have to pay the professional fees of an attorney, which you can use to make mortgage payments.

What is a forbearance agreement?

This is somewhat like loan modification, but it is not a permanent solution. If you have temporary difficulty or financial setbacks, then you can opt for this method.

Here the lender will allow you to suspend payments till you come back to a stable financial position. No act of foreclosure will take place within the agreed upon time limit.

After the end of the agreement, you have to become current on monthly payments.

If required, the terms of the forbearance agreement might be extended. You need to show further statements of financial hardships.

If you think modification and forbearance are your most viable options, then I would suggest you to go for it.

Refinancing a loan is a different dimension.

It is not at all modifying an existing loan.

What is mortgage refinancing?

You have an existing loan. Good.

You take out another loan and pay off the old loan. Now you have a new loan to pay off.

Is that all? Why should you choose a refinance option on the first hand?

You can opt for refinancing to lower the interest rate or to shorten your loan term.

So, paying less interest amount overall is a big reason for refinancing your mortgage loan.

Another good reason is, you can go for cash-out refinancing to tap your home equity and take out extra cash to tackle financial emergencies.

I know, taking out of home equity value is interesting. But don't get so impulsive. Always remember that you’d have to pay back the loan, otherwise you can lose your home.

You need to know the whole process of refinancing first.

If you are going for a term and rate refinancing then I would suggest you surf the market for loans with low-interest rates; otherwise, refinancing won’t make much sense.

In addition, you must also consider for how long have you been making payments on your existing mortgage.

If you have already cleared out the front-loaded interest amount on the loan, and washed out nearly half of the principal amount, then you might wanna give refinancing a second thought.

So let’s discuss the reasons for refinancing:

  1. If you are getting options to shorten your loan term. Let’s say, you have 20 years left on the present loan, and if you take out another loan, you will be able to clear your mortgage in 15 years.
  2. If you want to pull out your equity in liquid cash for some financial reasons, which will be a cash-out refinance.

If you are happy with loan modification then be so. Until and unless you are getting good chances to shift into a better loan module, or you desperately need to get hold of your equity, you should not consider refinancing.

So what are the ways to refinance for tapping into your equity?

This tapping of equity, while switching to another loan, is called cash-out refinance. It is named so because some part of your equity cash is coming out. So cash out.

To cut down the confusion, this is not a home equity loan.

If you take out a home equity loan, then you have two loans to clear out, one your primary mortgage and the other your equity loan.

In cash out refi, you will have only one loan to deal with.

Suppose your house is valued at $100,000 and your mortgage debt is $50,000.

Let’s say your son is planning for college and you need $30,000 by next month. Or, if your house needs a bit of remodeling or retrofitting and you need cash.

Here you can go for cash out refi. You will generally talk to some other lender or bank. Tell them your situation, that you have $50,000 equity built in your house, and your house is worth $100,000, and you need to refi.

Now you take out a loan of $80,000. You get $30,000 cash in hand, and with $50,000 you clear out your previous loan.

So, you now have this new loan to deal with.

Simple and easy.

Pickaboo!!

Why can't you pull 100% equity in cash-out refinance?

Rules!

The typical phenomenon is you are allowed to access about 60% to 80% of your total built in equity.

To access more than 80% of your home equity, you need excellent credit scores.

For refinancing, maintaining a good credit report and score is very important.

So what is better for me?

  1. Loan modification if you can make changes to the existing terms and conditions on the loan and are comfortable with it.
  2. If the market rates on mortgages are high, then probably you want to skip refinance and go for a loan modification.
  3. Going for forbearance if you find making payments is impossible for the time being. But, don't forget to take help of a law firm.
  4. You can refinance if loan modification agreement is rejected several times by the lender, and you need to make adjustments to your mortgage anyhow. But look out for the market rates.
  5. Going for a cash-out refi if you need liquid cash for some grave financial emergency.

To keep in mind, your equity cash is not something to mingle with. It is an asset. Don't use this cash for normal purchases or activities. Use it sincerely. Have a brief talk with a financial counselor before going for a refinance, specially cash-out refinancing.

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