Bankruptcy & Loan Modifications

Homeowners who can’t afford their mortgage payments can get a better deal from their lender. Loan modifications or mortgage modifications are designed to keep the homeowner in their homes though changing the terms of their existing mortgages to something more affordable for the homeowner. Refinancing on the other hand aims to simply pay you’re your existing mortgage by securing a new mortgage, at a different interest rate, or term of years, coupled with a host of closing costs. The key to remember is that a refinance doesn’t pay off the debt; it just restructures it, and generally adds to the principal owed.

An “affordable” payment typically is defined as a specific percentage of the borrower’s monthly gross income.  The common targeted range falls between 30 and 40 percent.  The modified payment must be sufficient to pay off the loan, sometimes with the term extended to 40 years and in many cases with some of the principal deferred until the loan is refinanced or the home is sold.

Many homeowners who are in high interest or variable rates believe refinancing is their best option.  However, refinancing your mortgage can reduce your overall financial benefit as opposed to a loan modification. Those who refinance will pay a heavy price by incurring many thousands of dollars in closing costs.

In order to justify the massive closing costs associated with refinancing, a homeowner should intend to be own their house for quite some time in order for refinancing to make sense. According to an August 2008 report on Bankrate.com, the national average for closing costs on a $200,000 loan is $3,118. The fees in the survey don’t include additional taxes, mortgage insurance or any prepaid items such as prorated interest or homeowner association dues, which can add several thousand dollars more.

If you are considering refinancing, you should calculate how many months you will need to stay in your home simply to pay off the closing fees.  On the other hand, there are no closing fees, no additional taxes or insurance and no pre-paid items incurred through a loan or mortgage modification.  For example, if your monthly payment goes down by $165, it would take 20 months of lower payments to recover the average closing fees.
If you are in a newer mortgage, there is also the potential to incur a prepayment penalty on your mortgage should you refinance too soon.   As such, if you’re struggling to make your mortgage payment, a mortgage modification may be much more advantageous for you then refinancing.

There are many types of loan modifications that may be offered by your bank such as:

• Repayment plan
• Interest-rate reduction
• An extended payback period (usually 40 years)
• Conditional forbearance
• Foreclosure stay
• A deferral of principal (usually at zero interest).

The one caveat to consider in choosing a loan modification rather then refinancing is that loan modifications are designed to prevent unnecessary foreclosures. They are not about creating great investment opportunities.

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