Loan Modification or Refinance? Which is Better?

By Gina Pogol
Mortgage Credit Problems Columnist

Wayne Asks: Dear Gina, I have a bad credit mortgage that's a couple of years old and I am sure that I could get a better interest rate. Should I refinance through a government program or should I try to get a mortgage modification?

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Gina Says:

Dear Wayne,

The right option for you depends on the answers to a few questions.

1. Is your current home loan owned or serviced by Fannie Mae or Freddie Mac? Most subprime or bad credit mortgages are considered non-conforming home loans because they do not comply with the underwriting guidelines of Fannie Mae or Freddie Mac. In that case, you can't take advantage of the government's Home Affordable Refinance Program (HARP). You can look up your loan to see if it is owned by Fannie or Freddie. If it is, you may be able to refinance your mortgage, even if you owe more than your home is worth. However, you can't have bad mortgage credit--home loan payments over 30 days late in the past 12 months automatically disqualifies you for HARP.

2. Does your current housing expense (monthly principal, interest, taxes, and insurance) exceed 31% of your gross monthly income? You may qualify for a mortgage modification under the Home Affordable Modification Program (HAMP) if your current mortgage has become unaffordable, especially if it's because of an interest rate adjustment (many bad credit mortgage rates reset after the first two or three years) or a reduction in income over which you have no control over.

3. What if you qualify for either program? If you have a Fannie or Freddie mortgage, but your total house payment exceeds 31% and you are in danger of defaulting on your mortgage, try for a modification. Your rate could be dropped to as low as 2%, and you won't have the costs associated with a refinance. Keep in mind that you need a stable and sufficient source of income to qualify for a modification--if you don't have a job or other reliable and ongoing source of income, you may not get the help you need.

4. What if you qualify for neither program? Try refinancing from your bad credit mortgage to an FHA home loan. You only need 3.5% home equity to do it. Or, contact your lender--just because you don't qualify for HAMP or HARP doesn't mean that your lender won't work with you--especially if you owe more than your home's value. You can ask for a forbearance, which means that you'd be allowed to skip one or more payments; again, the missed payments would be added to your balance.

5. Last resort: talk to a lawyer. You may be able to negotiate a short sale of the property and get your lender to accept the proceeds as payment in full. This should be worked out by a professional if possible, so that you don't end up with a lender chasing after you for fees and a foreclosure on your credit.

Good luck and thanks for writing.

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