Refinance vs. loan modification: Which is better?

Consider these things as you decide whether to change the terms of your loan via a refinance or loan modification. (iStock)

The coronavirus pandemic has had an undeniable impact on personal finances. Amid record levels of unemployment, many Americans are having trouble staying on top of monthly payments. That struggle — combined with record low-interest rates — has led many people to consider a refinance or loan modification. The question is: Which is better for your financial situation?

Here's what you need to know before changing the terms of your loan.

Is it better to refinance or get a loan modification?

There are some distinct differences between refinancing your loan and getting a loan modification. Before you can determine which option is best, you're going to need to fully understand the definitions of each — as well as their pros and cons.

What is refinancing? 

Refinancing a loan involves taking out a new loan and using it to pay off your old one. Doing so allows you to change the terms of your loan or to take out more than you owe on your loan in order to use the excess to cover a big expense. Notably, you don't have to refi through your current lender, so you can shop around for the best refinance rates.

To learn more about refinancing -- whether it's your student loans or mortgage -- turn to Credible. Credible can walk you through the process from start to finish and help you compare lenders and rates within just minutes (with no impact on your credit score). Plus, it's free.

For those with private student loans, you may want to take a look at Credible's rate table, which allows you to compare private lenders based on your loan type, loan amount, and more.


Pros and cons of refinancing


You can take advantage of the current low rates 

You can lower your monthly payment

You can change the terms of your loan (you can switch from a fixed-rate mortgage to an adjustable-rate loan or from a 15-year loan to a 30-year loan)

You have the option to borrow more money than you currently owe on the home

To increase your chances of obtaining the lowest refinance rates, make sure you compare mortgage lenders. Luckily, there are free online tools available that make refinancing your mortgage easy. By entering some simple information, you can pre-qualify in minutes.



You'll have to pay closing costs 

Your savings will vary (based on your current interest rate and time in the home)

You'll have to go through the underwriting process again

What is a loan modification?

Rather than taking out a new loan, loan modification involves changing the terms of your existing loan. In this case, you will work with your existing lender to modify the loan terms in order to make your monthly payments easier to manage.

While it's not necessary to go through the underwriting process again for a modification, it is necessary to get your current lender to agree to the change in loan terms. For this reason, loan modification is less common than mortgage refinancing and often only happens if your loan is underwater or you are significantly behind on your payments.


Pros and cons of loan modification


Accepting a loan modification can sometimes help you avoid foreclosure

You may be able to secure better, more affordable loan terms

You don’t have to pay closing costs in order to modify your loan (although there are sometimes processing or legal fees associated with loan modification, those are often wrapped into your principal balance).


Modifying your loan may negatively impact your credit score

There's no guarantee your lender will agree to modify your loan terms

If you miss a payment after modifying, it can escalate the foreclosure process


How can refinancing or loan modification affect my debt?

Depending on what kind of debt you’re struggling with, refinancing and loan modification may be handled differently. Here’s how common types of debt are affected:

Mortgage debt

Though the terms of a home mortgage modification are often up to your lender, this process might involve extending the length of your loan term, securing a better interest rate, or changing from an adjustable-rate mortgage to a fixed-rate loan in order to help you save on mortgage payment. While it’s possible to do all of those things with a home refinance as well, in this case, you’ll have more input on the terms of your new loan. 

Visit Credible to explore your mortgage refinance options and to compare rates and lenders.

Student loan debt

Where student loans are concerned, your modification options will largely depend on the types of loans that you have. Federal student loans, for example, allow you to modify the loan by changing your repayment plan. Notably, income-based repayment plans are also available. Meanwhile, private student loan debt modification options often vary according to the lender. 

While Federal Student Aid does offer a way to refinance student loan debt through a consolidation loan, if you have your heart set on doing a student loan refi it will most likely be through a private lender.

If you can qualify for a student loan refinance at a lower rate than you're currently paying, there are often no downsides to refinancing. You can use Credible to compare student loan refinancing rates from multiple private lenders at once without affecting your credit score.


Use an online student loan refinance calculator to get a sense of what your new monthly payments could be.

Personal loan debt

For the most part, modifying a personal loan will be similar to modifying your mortgage. You’ll work with your lender to modify the loan length or otherwise make your payments more affordable. On the other hand, refinancing gives you the chance to shop around for a loan with better terms. 

Looking to refinance your personal loan? An online marketplace like Credible can help you see your loan options.


The bottom line

Ultimately, the decision on whether to modify or refinance your loans depends on whether you can afford your current payments. Either way, changing the terms of your loan could be a way to take advantage of the current record interest rates and to lower your monthly payments. Don’t hesitate to reach out to your lender to ask about the possibility of either option.