If you’ve fallen on hard times, you may be looking for ways to lower your monthly mortgage payment.
All lenders provide some sort of loan modification or refinance program. They usually have strict eligibility requirements like low debt-to-income ratios, good credit history, and generous home equity. They’ll want to offset their risk as much as possible with any kind of loan restructuring.
But what if your home is worth less than the price you paid for it?
You’ll find a few “zero” or “low equity refinance” options out there, but the loan modification options for financially-strained, negative equity homeowners who want to stay in their home are virtually nonexistent. Or, they could put a dent in your credit report.
There is another, presumably less ideal but less damaging option, however: a short sale.
In this article, we’ll make the case that a short sale is a better alternative than loan modification for some underwater homeowners.
Loan modification vs. Refinancing
Loan modifications and refinancing are two different ways of changing the terms of your mortgage. Refinancing is replacing your home loan with a new loan, whereas loan modification is changing or modifying the terms of your existing loan.
Homeowners usually refinance to take advantage of a lower interest rate or to lower their monthly payment by lengthening the mortgage term. Some people even take cash out of the equity in their home during a refinance.
Refinancing affords homeowners lots of flexibility. They can pick a new bank to work with. They can reduce their loan term down to 10 or 15 years by increasing their monthly payment. Or they can lower their monthly payment by lengthening their loan term back up to 30 years.
Because it’s technically a brand new mortgage, you go through the same income verification and appraisal process as you did with the first loan. There may be equity requirements as well, especially if you wish to do a “cash-out refinance”.
If you are experiencing financial difficulties, have missed some mortgage payments, or if your home equity is low or negative, you may not be eligible to refinance.
About loan modifications
As mentioned previously, a loan modification is made to your current home loan and may be an option for homeowners who are at risk of foreclosure.
You might be eligible for a loan modification if:
- You’re behind on mortgage payments and ineligible for other loan products
- You still have a source of income and will be able to make modified loan payments
- You’ve experienced a qualifying financial hardship
There are many ways in which a struggling homeowner could benefit from, or be further damaged by, a loan modification. Let’s explore the pros and cons:
Pros of loan modification
- Reduce your monthly loan payment
- Stay in your home
- Opportunity to switch to a lower interest rate (if the bank allows), even if you’re not eligible for a traditional refinance
- An option for “underwater” or negative equity mortgages
- Possibility of some principal forgiveness
- Avoid foreclosure and its damage to your credit score
Cons of loan modification
- Need to show proof of income and financial hardship
- Going back to a 30-year term (back to square one)
- It may lower your credit score some
- You are beholden to your lender’s approval
- Any debt forgiven may be subject to tax
- You may have to pay some fees
Perhaps the largest con is that a loan modification may not materially improve your financial situation.
Struggling homeowners often regard the loan modification as their saving grace (and it can be!). But the mortgage is not your only monthly bill. In time, life catches up and you’re once again looking at ways to reduce your mortgage.
Your bank likely won’t let you modify your loan twice. And if they see you defaulting on loan payments again, they’ll ramp up foreclosure proceedings and escalate your case to the front of the line.
If you’re not sure that your financial situation or your home value will improve quickly, you might be better off short-selling now and starting fresh in a more affordable home.
Short selling as an alternative to loan modification
A short sale is when you sell your house for less than you owe on your mortgage. In most cases, the “shorted” balance is forgiven by your lender, allowing a struggling homeowner to walk away virtually scot-free. (Minus a temporary ding to your credit score and reduced buying power for a couple years.)
Lenders accept the loss because it saves them from dealing with a foreclosure, which is costly and time consuming.
Short sales are a routine but delicate process that requires guidance from a team of experienced real estate professionals. Namely, a real estate broker with short sales experience and an attorney or short sale negotiator.
Short sales don’t cost you anything out of pocket. Broker and attorney fees are paid through the sale of your home.
Most lenders even provide some relocation funds to help you move to your next home. (For instance, at the Fed City Team, we guarantee you Relocation Assistance of $3,000 or more.)
But how do you know when to choose a short sale versus a loan modification?
It all comes down to how dire your finances remain after a modification, and how long you anticipate your hardship to last.
Short-term vs. long-term hardships
It’s time to do some deep introspection and figure out if your current financial slump is expected to last a while.
Falling into hard times can happen suddenly – like a house fire, or the death of a sole income-earner. Or it can happen gradually, like building up credit card debt or medical bills over a few years.
One day you wake up and realize that you’re no longer living comfortably.
As the largest monthly expense, the mortgage is first to come under scrutiny. In your head you might be thinking, I just need to save up so much. Or, I just need to get my mortgage under $X.
Naturally, you’ll want to exhaust every option. Run every calculation. Consider every scenario. All the while you subdue the question,
How long will this last?
There’s a well-known domino effect theory with regards to global economies – how one country’s financial struggles (or gains) tend to seep into global markets. The same concept is easily applied to personal finance.
Today you may be tightening your belt, seemingly temporarily. But the deferred maintenance on your roof leads to a leak. Your budget-friendly car desperately needs repairs. Your property taxes increase for the new school being built.
Meanwhile, selling the home you can’t afford right now allows you to get past these hard times faster, and with considerably less stress.
Future-proof your decision
If your hardship seems like just a “hump” to get over right now, consider where you’ll be in 1 year. Three years. Five.
When can you resume leisure activities? When can you add non-essentials back to your grocery cart without thinking twice about it?
No one loves the idea of uprooting family, downsizing, or selling off possessions. These are difficult decisions, made even harder by the emotional connection we have to our homes. Not to mention the psychological impact of feeling like we’ve let down our family, or despair from coming so far in life only to be pushed backwards.
Believe us – you are not alone, and it will get better. How quickly depends on you and the decisions you make now about what to do with your expensive mortgage payment.
If you’re experiencing financial difficulty and upside-down on your mortgage, it’s important to gauge whether your situation is truly temporary or has the potential to compound further.
If your financial situation is expected to improve soon and you just need to get over a rough patch, talk to your lender about the possibility of loan modification. The U.S. Department of Housing and Urban Development (HUD) also offers free counseling services by state for avoiding foreclosure.
If, however, no amount of number-crunching can give you an affordable monthly payment and you are underwater on your loan, talk to a real estate professional about a short sale.
The short sale process carries its fair share of stress and financial impact, but with an experienced team of professionals on your side, you can come through this virtually free and clear.
Remember that your house is just 4 walls and a roof. It used to be an asset. Now it’s a liability. Don’t let your attachment to your property risk your financial security.
Your home is where you make it.
If you live in the Washington, DC metro area, call Marc Dosik and the Fed City Team to discuss your options for a short sale. Marc and his team have rescued over 130 home owners from foreclosure proceedings. They help you sell your home and work with your lender to get the mortgage deficiency forgiven, all at no cost to you. They even negotiate with the lender to pay your relocation costs, giving you $3,000 or more cash-in-pocket to help you get back on your feet.
Want to learn more about the short sale process?
Download our FREE ebook: How to Sell Your House in a Short Sale. Get your copy today!
Disclaimer: Every homeowner’s situation is unique, and local, state and federal laws change regularly. As such, this information should not be considered as legal, tax, financial or investment advice. Consult a qualified professional before making any financial decisions.