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If you’ve been scrutinizing your budget lately, and considering ways to save money, your monthly car payment is probably an expense you’d be happy to shrink. Fortunately, there are options available to drivers seeking to rein in the cost of car ownership without letting go of their ride.
Loan modification is one approach to a more manageable car payment; another is loan refinancing. Loan modification and refinance are not the same, and it’s important to understand the differences before pursuing a solution with the assurance that it’s right for you and your unique financial situation.
Let’s explore the advantages and disadvantages of both loan modification and refinance.
Both loan modification and loan refinancing are processes that make changes to a form of debt instrument like an auto loan or a mortgage. Their functions are somewhat similar, however, the outcome of each process is different. Loan modification is more common when it comes to mortgages than auto loans, but here we’ll focus on auto loans.
When you refinance an auto loan, you are taking out a new loan (often with a new lender) that pays off your current loan, where your vehicle is the collateral securing the loan, much like how real estate is the collateral for a mortgage.
The loan modification process does not replace your auto loan. Instead, it makes adjustments to the terms of the loan you have.
There could be many objectives served by an auto loan refinance. Some use this process to add or remove a co-borrower from the loan (and loan modification can’t do this). Because you’re getting an entirely new loan, the interest rate, duration, and loan amount all could be subject to adjustment. If you submit a down payment as part of a refinance, the loan amount would decrease.
Each of these factors influences the monthly payment on the loan, so it’s possible through a refinance to lock in a significantly lower monthly payment than you had been paying previously. In fact, this is one of the most attractive benefits of refinancing.
Typically, drivers refinance with a different lender than the one that holds their original auto loan.
With loan modification, on the other hand, you’re requesting that your existing loan carrier alter the structure of the loan you already have. These alterations could include adding more months to the loan’s duration, changing the interest rate on the loan, and changing the type of loan, such as from an adjustable-rate loan to a fixed-rate loan.
That said, in the case of cars it’s rare for lenders to offer adjustable-rate loans; fixed-rate loans are far more typical.
When an auto loan borrower approaches their lender with a request for a loan modification, it’s usually to access a more favorable rate and/or extend their current loan, with the goal of achieving a more budget-friendly payment structure.
Borrowers may resort to loan modification when there’s a financial hardship affecting their ability to cover the cost of the loan. For instance, if a job loss has led to a sharp reduction in income. In cases where the driver has gotten behind in payments and repossession is looming, auto loan modification could be a solution that enables that driver to keep their car.
Depending on your financial situation, refinancing an auto loan is going to be a preferable pathway to reach a more affordable car payment. When you refinance, you have the freedom to shop around for the best deal from a variety of potential lenders and use refi marketplaces like RateGenius to access a range of offers.
With loan modification, you’re dealing only with your existing lender and any new agreement is at their discretion alone. Moreover, proceeding with an auto loan refinance isn’t likely to adversely impact your credit score as much as a loan modification will (more on that further below).
Plus, when you refinance your auto loan, there’s an opportunity to affordably roll in protection plans, such as a vehicle service contract, that can help you avoid out-of-pocket costs for maintenance and repairs as your vehicle ages.
Some borrowers may wonder if refinancing remains a viable route to savings if they’ve already modified their auto loans.
If you’ve undergone a loan modification, it’s possible that you won’t be able to refinance that same loan until 12-24 months have passed, during which time you would need to be in good standing with regard to payments.
This is generally true of home loans. Refinancing an auto loan that has been modified may be challenging, as well. This is a question to bring up to your lender, as well as any prospective new lenders you’re considering as you shop for refinancing.
There are other factors that might restrict or dissuade you from refinancing a loan that’s been modified. Regardless of whether you have had your existing auto loan modified, any new lenders evaluating a loan application will want to see, among other things, a history of 6-12 months of timely payments.
If the auto loan modification process has negatively impacted your credit score, it may be wise to take time to build it back up before seeking out a refinance, as a higher credit score generally means access to more favorable rates.
In times of financial hardship, auto loan modification could be the solution that enables you to keep your car when it’s at risk of being repossessed. However, if you find your auto loan is no longer affordable, loan modification comes with some notable drawbacks.
The process can take a while. Producing and gathering the required documentation can be burdensome for the borrower. Many lenders will ask you to write a so-called hardship letter explaining your financial predicament.
The lender may take a long time to decide on a loan modification request.
This is different from a refinance application because lenders want to respond quickly to refinance requests to win your business.
With a loan modification request, your existing lender will carefully consider whether it’s in their best interest to accommodate your request.
Also, bear in mind you’re not protected from car repossession simply because you’ve started the dialogue with your lender regarding loan modification. If you’re behind in your payments, this remains a risk.
Let’s say you go through with an auto loan modification. It’s likely that your auto lender will report this to credit bureaus, which signals that you are facing financial trouble. This may prompt the bureaus to lower your credit score based on their scoring models, thereby limiting your access to more affordable rates on loan products in the future.
During the refinance application process, the lender reviewing your application will conduct a hard credit inquiry in order to evaluate your creditworthiness. But inquiries into your credit—especially if those are infrequent—aren’t typically going to be major drags on your credit score.
If you extend your auto loan term through modification, it’s likely that the additional payment cycles will bring up the overall cost of the loan itself, in the form of more interest charges over the life of the loan.
You may have to wait 1-2 years before you can refinance an auto loan that has already undergone modification. There are no standardized rules governing how soon after a loan modification a lender would permit a refinance; it’s chiefly up to the lender and their specific policies.
One of the most critical factors at play is a borrower’s financial standing. Especially important are credit score, credit utilization rate, and debt-to-income ratio. Adhering to smart financial practices like regularly paying your loan and other bills on time is one way to position yourself for success when you apply for refinancing.
Attempting to secure an auto loan refinance too soon after a loan modification—which usually follows periods of financial trouble—may have low odds and therefore not worth your effort.
As we learned, loan modification should be considered a measure of last resort if you’re in acute financial distress and carrying an auto loan. There are some major drawbacks to loan modification, including impacts on your credit score.
If you foresee your auto loan payment becoming too costly, start by exploring refinance. This process can improve your financial standing by delivering a more manageable monthly payment, without the headaches and long waits associated with loan modification.
Learn how much you can save refinancing with RateGenius’s Auto Refinance Calculator.
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