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Posted May 16th, 2012 under Upside Down House Options

Loan Modification or Mortgage Refinance: Two Options for Underwater Borrowers

Tags: home loan modification, mortgage refinance, options for underwater borrowers

Loan Modification or Mortgage Refinance: Two Options for Underwater Borrowers

Underwater homeowners who are looking to make their mortgage more affordable have two main options: home loan modification or mortgage refinance. While they sound similar (and people sometimes use the terms interchangeably), loan modification and refinance are actually two quite different options for underwater borrowers.

In a home loan modification, your lender agrees to modify the terms of your underwater mortgage so that you are better able to afford your payments. For example, your lender may agree to lower your interest rate, change the type of loan you have, or change the payoff period. In some cases, these loan modifications are temporary, while in other cases the adjustments to your mortgage terms may be permanent.

Generally, the federal government has pushed loan modifications as one of the best options for underwater borrowers. And for some homeowners, loan modifications are a good solution, particularly if they plan to remain in the home for several years, they can afford the modified mortgage payments, and their negative equity is less than 10 percent of the total value of the house. But loan modifications have some disadvantages. One of the biggest issues is that loan modifications can take months to process, and many homeowners report that their bank threw up roadblocks (such as "losing" paperwork) that further delayed the process. In the worst cases, homeowners may wait months only to have their lender deny their request for a loan modification. At that point, the homeowner's only remaining options may be short sale or foreclosure. Also, to obtain a loan modification, homeowners must demonstrate financial hardship. That often involves missing mortgage payments, which will hurt your credit score.

For homeowners who are underwater but in good financial shape otherwise, mortgage refinance may be an option. Unlike a home loan modification, which involves modifying the terms of an existing mortgage loan, with a refinance you apply for an entirely new mortgage loan. The new loan (which typically has a lower rate and more favorable terms) replaces the original mortgage.

To qualify for a mortgage refinance you need to have good credit, since you're applying for a new loan. So if you're already behind on your mortgage payments, a refinance likely won't be an option for you. The other problem is that if you're underwater, it's going to be hard to get a traditional refinance because you don't have any equity in the home. However, some underwater borrowers may qualify for the federal government's Homeowner Affordable Refinance Program (HARP), an initiative that is specifically designed to give underwater homeowners access to mortgage refinancing.

So, should your pursue a mortgage refinance or try to get a loan modification? The answer, of course, depends on your specific situation. Each path involves different steps and has different consequences. To help you evaluate your different options, we created the Underwater Homeowner Assessment and Action Plan. We'll look at refinancing, loan modification and your other options to help you make the choice that's right for you.