Mortgage Modification or Refinance — What’s The Difference?
Is it better to modify a mortgage or to refinance? While both result in new loan terms, the two choices are very different.
When you refinance a mortgage you replace an existing loan with a new one. There’s no need to negotiate with the old lender because his mortgage claim will be extinguished. However, borrowers with toxic loans need to see if a refinance will set off claims for a huge prepayment penalty at closing, perhaps an amount equal to mortgage interest for six months.
Mortgage modifications come in several forms. First, we have loans which automatically self-modify — that’s the nature of an adjustable-rate mortgage (ARM).
Next we have mortgages where the lender voluntarily agrees to modify loan terms. Given that a mortgage is a contract such voluntary modifications are rare. Voluntary modifications might include changes in rates and terms, and also assumptions where one borrower takes over the debt of another with permission of the lender.
Tough Times
Because of the foreclosure meltdown we now have government-organized modifications under the Making Home Affordable program. In basic terms such modifications are open to those facing foreclosure or who have lost so much equity that financing to a new and lower rate is now possible outside the program.
Owners Versus Investors
When principal balances are reduced it’s possible for investors to face federal taxes on the unpaid balance, money that’s regarded imputed income. For example, if a $100,000 mortgage is settled for $75,000 then the unpaid $25,000 has traditionally be considered taxable income under federal rules. However, if the loan being modified is for a personal residence, then under Mortgage Forgiveness Debt Relief Act of 2007 the amount forgiven is generally not be taxed by the federal government. For specifics, please speak with a tax professional and be sure to ask about both federal and state policies.
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