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Mortgage Modification or Refinance and Credit Score

Should I refinance now, or do a loan modification and then refinance?

How much will a modified refinanace (4-5 mths with reduced payment) hurt our credit score? Then refinance to lower rate and pay full payment.We both are in the upper 700s to 800 credit score.

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Bill's Answer
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Mortgage Modification or Refinance? Check your financial health

Thank you for your question about loan modification, credit score and refinancing.

Your question is a bit unusual, given the fact that your credit score is so high. In general I would recommend that you take advantage of your good credit scores to refinance your loan. That means of course maintaining a perfect payment record. (Even a HARP refinance loan for underwater borrowers requires a perfect payment record for the last 6 months).

If you are looking for a short-term loan modification, then I assume that you are having some temporary cash flow problems. We will get back to this issue in trying to determine what is your best option.

In order to answer your question about mortgage modification, credit reports and refinancing, here are some questions that you should ask yourself:

  • What alternatives are there if I am having trouble paying my mortgage?
  • How can I protect my credit score?
  • Will I Qualify for a Mortgage Refinance or Mortgage Modification?

Mortgage Payment Problem Alternatives

In order to maintain a good credit score, the single most important criteria is to make your payments on time. Your mortgage payment is a crucial part of your credit history. It is generally a large payment for a crucial living expense.

However, any of us may have a certain hard period, due to unexpected expenses, especially medical bills, or lower income. It is highly recommended to have an emergency saving fund, that will allow you to ride out a 6 month period.

So what happens if you cannot make your monthly payments, or feel that you need to lower your monthly payments? Here are some of your alternatives:

Action Reasons Credit
Refinance Lower your monthly payment through a mortgage refinance or a cash-out (loan consolidation) refinance. By stretching out the length of the loan (and hopefully lowering your interest rate) you can lower your payments. In general you need a strong credit score and DTI (debt to income ratio) to qualify.
There are special programs for lower credit (FHA refinance), or underwater borrowers with low credit (HARP refinance and FHA streamline refinance).
Forbearance Lower your monthly payment for a limited time by making no payments, interest only payments, or interest and limited principal payments, through an agreement with your lender. You will need to show a financial need to get your lender to agree to a forbearance agreement.
Modification A mortgage modification is a formal agreement between you and the lender that changes the terms of the original loan. A modification includes a lower interest rate and/or a longer period, resulting in a lower monthly payment. The modification usually is for a trial period and then includes a long term final agreement. You will need to show a financial hardship. Although not mandatory, a mortgage modification is usually done after missing payments. Missed payments (or other bills not paid on time) means a lower credit score.
You must also be able to show that you can make your modified monthly payments.
Other Alternatives If you cannot reach an agreement with your lender to modify your mortgage and keep your house, then your options are limited between defaulting, a short sale or deed-in-lieu of foreclosure, and foreclosure.
Speak to your servicer's relevant foreclosure avoidance department and if necessary a bankruptcy lawyer.
Any of these alternatives, which involve not making your payments, have a strong negative effect on your credit score.

How can I Protect my Credit Score?

If you want to refinance your mortgage, then maintaining a high credit score will aid you in obtaining a low interest loan. The best way not to harm your score is to make your payments on time.

This leads us to your question regarding making reduced payments on your mortgage, whether it is a loan modification trial period or a temporary forbearance period. Unfortunately, the answer is not so simple. It depends on the manner that the lender (servicer) reports your payments.

I recommend that you speak to your servicer before changing your payment amount. Make sure that your agreement is in writing. Ask for a confirmation regarding the manner that your payment will be recorded. If you have an agreement to make partial payments, or a full grace period, then your record should not show a delinquent payment. However, if you reach a loan modification agreement, then it is common for your lender to report the modification with a special code. For example, Experian uses the special comment code "AC" to note that "paying under a partial or modified payment agreement"

Will I Qualify for a Mortgage Refinance or Mortgage Modification?

In order to qualify for a mortgage refinance you will need good credit including:

  1. A good credit score: Most lenders require a FICO score of at least 620-640, but for the best rates you will need over 730.
  2. A good credit history: Although a few delinquents may not disqualify you for a loan, if they are recent, they could ruin your chances of getting a refinance loan. Collection items, foreclosures, and bankruptcies are very serious negative marks against your credit.
  3. Stable income: Stable income is also important. This can be a problem for many self-employed borrowers, whose income fluctuates and/or is not easily documented.
  4. A strong debt to income ratio: Although there are different loan requirements, most lenders require a DTI of 43-45% maximum, and a mortgage payment DTI (principal, interest, property insurance, property tax, HOA fees) of no more than 26-31%.

The fact that you are looking into a modified refinance, which I assume is either a forbearance or mortgage modification agreement, indicates that you are facing some type of hardship. This is like waving a red flag in front of the lender. If you are seeking a lower payment, due to lower income levels, then go directly for a refinance. However, don't take on new short term credit (by using your credit card or payday loans), because those will hurt your credit score and also raise your DTI.

If your problem is short term in nature, then look for other solutions, such as dipping into your investment accounts, 401-k loans, family loans. If your financial troubles are a hardship, then concentrate your efforts on getting a loan modification. Your credit score should not be your primary concern, because if you can't make your payments, then your credit score will be seriously damaged.

I hope this information helps you Find. Learn & Save.

Best,

Bill

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