Modify or Refinance?

The real estate industry is confusing enough without all of the jargon that gets thrown around. Borrowers who don’t understand the meaning of this jargon can find themselves paying a hefty price for their lack of understanding. Two terms that are often confused are “loan modification” and “mortgage refinance”. These two terms describe two different practices that ultimately accomplish the same desired effect, a lower monthly payment for the borrower.

Home loan modifications modify the terms of an original mortgage contract, but in most cases maintain the amount of time that remains on the contract. For example, home loan modifications approved 10 years into a 30 year loan will continue to have 20 years remaining on the loan. Home loan modifications reduce monthly payments, in most cases, by reducing the amount of interest the lender collects from the time of modification approval to the time of the expiration of the contract. Home loan modifications do not generally add time to a loan, which is good for borrowers who want to stay on track with their original 30 year plan.

Mortgage refinancing, on the other hand, takes the amount that remains on one loan and extends it to a full 30 year loan, starting the clock all over again for the borrower. While it is true that mortgage refinancing will lower payments, borrowers must ask themselves “at what cost”. If a borrower doesn’t care about the length of their loan, only the amount of their monthly payment, then a refinance may be the best option.

In general, it is best not to add time to a loan if it can be avoided. The reason to avoid adding time to a loan is simple; the borrower simply has no way of telling the future and has no way of knowing how financially secure they will be in another 30 years. Keeping the length of a loan down shortens the amount of time that the borrower has to look into the future. For many, it is far easier to predict how financially secure they will be in 10 years rather than 30. A person who plans on retiring after their home is paid off would risk having to spend their retirement check on their mortgage if the mortgage is refinanced to another 30 year term rather than modified to a lower interest rate.

No matter which option the borrower chooses, it is important for them to remember that a lower monthly payment is not a blank check issued by their lenders. A lower monthly payment often means that saving for the future becomes easier. If a monthly payment is lowered, the borrower is urged to put away as much of their monthly savings as they can into savings accounts and low risk investment options. This will ensure that the borrower has a bit of a cushion should financial trouble arise again in the future. If a borrower is able to pay off their mortgage without having to dig into their financial cushion, they can treat the funds as an additional source of retirement income.