Loan Modification or Short Sale – Which is the best debt relief option?

When homes become unaffordable for the owners, they often have to decide from either of the two – loan modification or short sale as their debt relief option. However, each of these mortgage debt relief options have pros and cons of their own, and so, one has to carefully weigh both of them, i.e., loan modification and short sale, before choosing any one.

First of all, it is quite a difficult question to answer, as to whether you should opt for a loan modification or for a short sale, since both of them depend partly on the following factors:

  • Your wish to retain your property.
  • The consent of the bank.
  • Your current financial health.

The situation may turn for worse, in case, the bank trashes your request to consider your home’s present market value. Alternatively, if you’ve determined to continue to stay in your present home, then irrespective of its market value, a loan modification might be your best route to get rid of the financial burden.

What are the terms of a loan modification?

Primarily, a loan modification will affect you in the following ways:

  • It’ll extend your loan’s maturity deadline.
  • Will lower your loan’s rate of interest.
  • Your loan’s principal balance will get inflated with the addition of unpaid interests.
  • Finally, a loan modification will reduce the overall principal balance.

Loan modification may inflate your monthly payment

It might seem weird but not all banks do agree to offer a loan modification help to their borrowers, especially in cases where the homeowner’s monthly mortgage repayment amount will get reduced. There are few banks that do a loan modification but will increase the monthly payment.

These financial institutions use different kinds of ratios to decide a fresh mortgage repayment amount. However, there is a cap of 38% with respect to the borrower’s gross monthly income beyond which banks cannot determine a new loan repayment amount. Depending upon the financial statements of the borrowers, banks may demand higher mortgage payment.

Both a short sale and loan modification cannot proceed all at once

There are many banks that won’t work on two files concurrently. You’ll have to decide well in advance as to whether loan modification or short sale would be your choice to obtain debt relief. It’s important that you choose one or the other.

The moment you approach your bank for a loan modification, then from that very moment, your bank will suspend any kind of ongoing short sale process. Basically, both loan modification and short sale processes take about the same time to complete. Certain loan modification process are found to have taken 3 – 6 months to finish.

In reality, this is unfair to the buyers who’ve submitted their respective good faith offers on a short sale property and are waiting for their individual short sale approvals, only to find out that the sellers have abandoned the transaction process midway, and that they’re working out a loan modification agreement with the homeowner instead.

Why a short sale might be better than a loan modification?

If you want your property to be out from underwater, then you may opt for a short sale in-lieu of a mortgage loan modification. Here, you’d have to pay a reduced loan amount to the bank and have your home released by it. Short sale will be better, if your home is worth less than the total amount owed.

You can buy another home after about 2-3 years of the short sale that would be affordable for you, provided housing prices remain stable. Moreover, both loan modification as well as short sale will have negative impact on your home. Still, they’re much better option as compared to foreclosure.