What's the Difference Between a Refinance and a Loan Modification?

By Dawn Handschuh, Personal Finance Writer Archive

Mortgage refinances have been under near-constant scrutiny since legislators, banks and homeowners have been searching for options to stave off foreclosures in the wake of the sub-prime mortgage crisis. Loan modifications, which until now were a lesser-known means of changing the terms of a loan contract, have also become an important tool that's being used by banks to alter mortgage loans en masse. But what, exactly, is a loan modification, and how does it differ from a conventional mortgage refinance?

Which loans are eligible?

Loan modification: Only the lender that currently holds your mortgage can process a loan modification. Your existing lender can only modify the loan if they haven't sold it on the secondary market. Most major banks do sell their mortgage loans, thus limiting the number of homeowners who can modify their loans. Smaller, community banks are less likely to sell your mortgage.

Refinance: If you wish to refinance your loan, you can do so by using the same lender that now holds your mortgage, or by refinancing with a new lender.

What changes?

Loan modification: A loan modification can reduce the interest rate you pay on your existing loan, extend the term or forgive some of the balance; however, a loan modification will not replace your old loan with a new loan. This represents an important advantage over a refinance, which effectively "resets the clock." If, for example, you modify your loan in the twentieth year of a 30-year loan, you'll still have 10 more years to pay on the loan (not 30) because you'll continue to hold the same loan.

Refinance: A mortgage refinance takes place when, in order to change the terms of the loan, such as the interest rate or the term, you replace your existing loan with a new loan and new terms. You're essentially starting from scratch with a brand-new loan.

What will it cost, and how long will it take?

Loan modification: Loan modifications don't require an appraisal or as much paperwork as a refinance, so they're generally less time-consuming. A loan modification may cost only several hundred dollars.

Refinance: Depending on your closing costs and your lender's fees, a refinance may cost several thousands of dollars. An appraisal is required, and your credit score will be a factor.

Your income will be verified in either a loan modification or a refinance, but both income and debt issues will be easier to overcome by doing a loan modification with your existing lender.

Prior to the mortgage crisis, lenders would decide which loans to modify on a case-by-case basis, but the Obama administration has made mass mortgage restructurings a priority in order to avert massive foreclosures. Speak with your lender to determine what your options are and what's the right choice for your family.