Refinance or Loan Modification: Which is a better option?

For borrowers who want to lower their interest rates or monthly payments, a straight refinance should always be the first choice. A refinance is a transaction that pays off an existing mortgage with the proceeds from a new mortgage. Despite the media’s increased focus on the difficulties in qualifying for a new mortgage these days, it’s very possible to get a new mortgage in today’s market.


As with most financial decisions, education and preparation are keys to success with refinancing. While there are no cut-and-dried rules for what lenders are requiring, there are a few trends that borrowers should note. First, for the most part, borrowers can expect to be asked to document their incomes and assets. That means they should be prepared to provide paperwork such as tax returns, pay stubs, W2’s and bank statements. Guidelines do vary slightly from lender to lender, especially for jumbo loans, but this is certainly the rule rather than the exception. If the loan amount is within the conforming limits, that loan will probably be underwritten according to Fannie Mae or Freddie Mac guidelines. Fannie Mae and Freddie Mac both require that the borrower provide proof of income, employment and assets.

In addition to documented income and assets, credit scoring is also a critical factor in determining whether or not a loan will get approved. Credit scores also help determine the pricing available to the borrower. These days, it’s not uncommon for lenders to add points or fees to a loan for borrowers with lower credit scores. It used to be that borrowers with credit scores in the high-500 range could still qualify for the lowest rates. That is no longer the case. For conforming loans, that minimum loan amount to receive premium pricing is roughly 740. Jumbo requirements for credit scores vary from lender to lender, but borrowers would be safe in assuming that the minimum score needed to qualify for premium pricing is roughly the same, at 740.

What’s Loan Amount (Conforming or Jumbo) Got to Do with It?

The borrower’s loan amount will dictate whether the mortgage is a conforming loan or a jumbo loan. A conforming loan is a loan at or under $417,000 in most areas, although there are higher conforming loan limits for certain higher cost areas, like Alaska, Hawaii and certain parts of California and New York.

The reason the conforming/jumbo categorization is important is because the loan amount determines who will buy or provide the funds for your loan, which impacts the rates available to you. Government entities Fannie Mae, the Federal National Mortgage Association and Freddie Mac, the Federal Home Loan Mortgage Corporation, only work with conforming loans. Fannie Mae and Freddie Mac are government sponsored enterprises, GSEs. They  do not loan money to borrowers directly. Instead, they purchase loans that were originated by banks and other lenders.

It works like this: If you go into Bank X to get a conforming loan, Bank X will help you with all of the paperwork and will even provide the money for the loan from its credit line. Then it will package your loan together with a bunch of other loans that were originated through the bank, and sell them to Fannie Mae or Freddie Mac. Fannie Mae and Freddie Mac don’t hold the loans as an asset. Instead, they repackage the loans and sell them as securities. It’s a lot like breaking a loan into pieces and selling it off as an investment to those that would like to earn interest. For jumbo loans, the bank would fund it, then usually keep the mortgage on its books rather than sell it. The loan would be kept in the bank’s portfolio generating interest income.

There are several reasons for the difference in interest rates for conforming and jumbo loans. Some of the factors include fewer credit lines available to banks to fund jumbo loans and fewer investors willing to purchase jumbo loans. In short, jumbo loans are considered riskier products for banks. Pricing on jumbo loans can be significantly higher than those for conforming loans. If you have a jumbo loan that you would like to refinance, you should contact a licensed mortgage professional. Bank of America is currently active in the jumbo loan market, as is ING Direct. Guidelines change quickly. Lenders enter or leave the market at a moment’s notice.

Loan Modification or Refinance?

For borrowers looking for more favorable rates or terms, a refinance transaction should always be the first choice. Loan modifications are for borrowers who are facing hardship and are in trouble with their mortgages. Loan modifications should never be used as a first option. There are currently very few guidelines on how loan modifications will affect a borrower’s credit. Unlike a late payment a loan mod is not automatically flagged as derogatory, however the details of the transaction are included on a credit report. It is possible that it could be construed as negative by a future lender while with traditional refinancing, the borrower’s credit rating should remain steady and intact. It may not seem like a major concern to people, but negative marks on a credit report can result in higher interest rates and payments for credit cards, auto loans and other debts.

If a borrower is not eligible for a refinance, then he or she may choose to investigate other options, such as a loan modification. Some of the more common reasons that borrowers are not eligible for refinancing in today’s market are: lacking enough equity in the property or being “upside down” in their mortgages (owing more on the loan than the property is worth), being unable to document their income, or suffering a recent financial hardship such as job loss. In such cases, it’s best to contact your lender directly to discuss options. For loan modifications, if you have the time you can either approach your lender directly, or employ a third party negotiator to act as a liaison between you and your lender. Make sue that your choice is a reputable business, with a track record, whose fees come with a money back guarantee if the loan mod isn’t accepted.

Get Prepared and Stay Educated

When contacting your lender to determine whether a refinance or a loan modification is right for you, remember that lenders are very busy answering calls from individuals who are confused or concerned about their loans. The person who answers the phone at the lender’s offices may also be inexperienced in handling the types of calls they’re receiving, and may not be able to answer your questions right away. If this happens, be patient but persistent. If you don’t get any information on the first try, you may have to call back two or three more times. While it can be frustrating to be put on hold or to be told, “I don’t know,” ultimately, it is the borrowers’ responsibility to get the answers that they need. In the mean time, it’s wise to gather the paperwork that will be required, such as tax returns, bank statements, a hardship letter and list of assets, liabilities and expenses. Have them ready to present to the lender. If at all possible be sure to keep paying your mortgage. You don’t want to risk foreclosure.

Remember, rates and guidelines can change with little notice. Although many experts predict that interest rates will stay fairly low throughout 2009, guidelines are subject to sometimes drastic changes that can impact how lenders evaluate a borrower’s income, credit score and loan-to-value.

Finally, while it’s very important to keep apprised of changes and opportunities in the mortgage market, be cautious about who and what you believe. Double check the information you receive and try to get the facts from a credible news source. Beware of too-good-to-be-true deals and scare tactics. If it sounds as if someone is trying to get you to act in haste, call a licensed mortgage professional or your current lender to discuss the options. Utilize the resources available to you. Borrowers don’t need to know all of the answers before they call their lenders or mortgage professionals. If you do not know how to begin the inquiry process, you can always start by asking your lender or mortgage professional, “What are my options?”

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