Loan Modification or Refinance? Weigh Payments and Fees

Q: This past February we obtained a loan modification with our current mortgage lender and I was now wondering (almost a whole year later) if it would be a good idea to try and refinance with them?

I am considering a refinance because there were about $3,000 worth of fees that we weren’t able to be put into the modification. Could the mortgage company, just make the $3,000 become due at any time?

A: You’ve obtained a permanent loan modification? Good for you. You’re part of a tiny minority of homeowners that have successfully obtained a loan modification from their current lender.

The real question to ask is whether you are better off with the loan modification or with a new loan: Will your monthly payments be lower with a new loan? How much will you pay to refinance your loan? What is your current loan balance and how many years do you have left on your current loan? Will refinancing cause you to pay more over the long run?

These are just some of the many questions you should be asking yourself before calling a lender to inquire about a refinance.

For those fortunate few that have obtained loan modifications from their current lenders, some have received very advantageous payment plans and reduced interest rates for their loans. Most find they’re paying a little less than they were before.

If your lender gave you a permanent loan modification and reduced your interest rate substantially, you might be better off with your current lender than trying to refinance your loan – especially if you don’t have much equity.

If you determine that your loan modification did not reduce your loan payments by much and you have significant equity in your property and your income supports the payments on a new loan, then you could consider refinancing but only if you can get the interest rate reduced substantially, the costs to refinance can be recouped in six to nine months, and you don’t increase the number of years left to pay off the loan.

Some homeowners make a mistake and refinance their current loan and get a lower monthly payment but then find the new loan requires them to pay for many more years. The net effect of refinancing a loan should not be to stay in debt for more years than before but to get a lower payment while keeping the remaining term of the loan the same.

For example, if you are seven years into a loan and refinance into a new 30-year loan, your monthly payments may be lower but you have added seven more years of paying your lender than you did before.

To compare both loans equally, you should use a loan calculator to determine what your monthly payment would be with the new interest rate offered to you if you had to repay that new loan off in the same 23-year that you have remaining on the current loan.

If you’re still saving money on a monthly basis, refinancing may be right for you. If your monthly payments would be higher, refinancing may be costing you more money over the long term.

You also have to keep in mind that your monthly loan payment should not include what you pay for insurance or real estate taxes. Your monthly mortgage payments should only be what you pay your lender for interest and principal payments.

Having said all that, you also asked about the $3,000 in fees that you incurred to modify your loan. Your loan documents should specify how that money was accounted for. It may be that the $3,000 will be added to the loan balance and that you pay it off over the life of the loan. Check your loan documents to determine how that obligation was handled. It would be unusual for the lender to have an immediate right to request the money at any time.

You should also take a look at your credit history and credit score. Many lenders reported their borrowers who went into a temporary loan modification program as making only partial payments, despite promising borrowers who were already paying on time that they would be reported as such.

If you were reported as delinquent on your loan payments, or as making only partial payments, your credit history and score might have been destroyed. With tighter requirements, you may not qualify for a refinance based on the current state of your credit history and score.

You can pull a free copy of your credit history at AnnualCreditReport.com. Take the opportunity and pay around $8 for a credit score as well.