Refinancing v. Loan “Modification”: What is the Difference?
If you are looking to refinance your home in the near future (as we are), you will probably be deluged with a ton of offers from various sources offering you better interest rates and “lower payments” on your existing mortgage. These offers are often from Loan modification companies, which are part of an industry that has sort of sprung up out of nowhere in recent months to deal with the rising tides of mortgages-gone-bad and distressed homeowners. I have personally received about eight million of these “offers” myself, and the wording is somewhat confusing and misleading, so I thought–hey, free ABDPBT Personal Finance topic.
First of all, let’s define our terms. A loan refinance is where you go in and basically sell your loan again to another lender, or the same lender (maybe) but under different terms. You don’t have to get your current lender to agree to anything really because you’re just, essentially, paying your old mortgage off. Except, you’re paying it off with another bank’s money, so you still end up with debt, but it’s to somebody else (probably) and under different terms (probably). If you do a loan refinance, you have to pay fees and do escrow and all that crap that you had to do when you were buying the house. Except you don’t have to have people looking through your cabinets or host open houses or whatever. The biggest problem with refinancing in recent years has been that people have taken mortgages out for more than they originally owed, so when the market went down, they lost equity and/or ended up being “upside down” on their homes, aka owing more than the homes are worth.
A loan modification differs from a refinance in that it is where you deal with your current mortgage lender and attempt to get them to renegotiate your loan. Usually, this will be in the form of extending a teaser rate for a longer period, or agreeing to allow a loan percentage rate to be fixed for a certain amount of time. On occasion, they might talk about “forgiving” parts of loan in circumstances of financial distress, if they know the homeowner cannot make payments or something. It just depends. A loan modification does not cost anything in and of itself, but there are a bunch of companies that have sprouted up lately that are offering to negotiate for you and in exchange asking for an upfront fee. It’s not clear that loan modification necessarily has an effect on your credit score, but I would guess that it does, since you are kind of working out a default deal with your lender, and I’m guessing that they won’t just keep that to themselves out of the goodness of their hearts.
So the problem with this industry of loan modification companies is that they are charging they eighty five million people who are candidates for loan modification for something that is provided for free or for a small fee by a bunch of nonprofit organizations. These companies send misleading paperwork to a bunch of people, and not just candidates for foreclosures, by the way, since I’ve received eight pounds of them in my mailbox lately and we are all current on our mortgage. The notices have kind of tricky wording that suggests they are writing from your current lender, but actually they are not. Here’s an example from one I received:
RE: Current Right-Click Mortgage Holder
Your mortgage, originally funded by Current Right-Click Mortgage Holder, may be eligible to be modified to a 30 year fixed rate mortgage with a payment of only [super low number] per month!
If you look at the fine print, it says “information obtained from public record sources and not by Current Right-Click Mortgage Holder.” So basically they are blanketing areas with modification offers, regardless of what the terms are of the mortgage, and regardless of financial circumstances. Why? Because if they offer that ridiculously low payment offer, then people are going to go, “Hey, maybe I should do that,” and be willing to pay the $500 to $3,000 they charge for negotiating these “modifications”!
Bottom line is that you do not need to go out and hire somebody to modify your loan for you. Not only that, you only need to modify your loan if you are at risk for foreclosure and cannot refinance. While it is not illegal to charge for these services, and while the companies themselves argue that what they are doing is providing a service that is necessary because of overwhelming demand, you want to make sure to stay away from things that you do not need and which may hurt your credit. I think the notices they are sending out, personally, are designed to get you to sign up for something you do not need because the process is so confusing. If you are concerned about foreclosure or in the midst of a financial crisis that you worry will lead to foreclosure, the Department of Housing and Urban Development has resources to help you. For state and local housing counselors that are certified by HUD, visit this link.