Negative Equity Refinancing Instead of Foreclosure
- 6 min read
- Refinancing is difficult if your LTV is 100% or greater.
- Lower your principal balance, interest rate, and monthly payment with the FHA Short Refi Program.
- Examine the Refi Plus program, if your lender participates.
Avoid Foreclosure with a Government Mortgage Refinance Loan
Housing values have fallen in many markets across the country.
Some people who have seen their home value plummet consider letting it go into foreclosure, because they may not be aware of any other options. Because foreclosure has such serious negative effects on a credit rating, it should be avoided if possible.
You may want to refinance your mortgage, but feel you cannot qualify for a loan because your house is worth less than you owe on it. If you are upside-down on your mortgage, you may feel that you are trapped in your home, unable to refinance or to sell your home. It is true that a large drop in your home’s value has a huge impact on whether or not you can refinance your current mortgage. Most prime loans require you to have a minimum of 10% equity stake in your home to qualify for a loan. You should not think, however, that there are no options available for someone in your position.
There are two main options for you to review, when in a negative equity position:
- Refinancing with your current lender
- The FHA Short Refi Program
Refinancing With Your Own Lender
If your current loan is backed by Fannie Mae or Freddie Mac, you may be eligible for the Refi Plus program. If you are not sure if Fannie Mae invested in your loan, you can check online.
Refi Plus loans can go out to 125% of your home’s fair-market value, according to the program rules, though most lenders will not refinance above 105% LTV. If your loan is not backed by Fannie Mae or Freddie Mac, check directly with your lender and see if they are willing to refinance in your negative equity position. Your lender may work with you because refinancing your loan will keep you from considering foreclosure as an option.
FHA Short Refinance Program
Another option is to look into an FHA loan. The Federal Housing Administration (FHA) initiated a new government loan program to assist homeowners who have seen their property values drop. The program, called the FHA Short Refinance, began on September 7th, 2010 and is slated to run through December 21st, 2012. The goal is to help borrowers in a negative equity position refinance into a more secure loan. Under the FHA Short Refinance program, a lender reduces the principal balance on the mortgage. The reduced-balance loan then passes from the private hands of the lender or investor that owns the loan to a loan that is guaranteed by the federal government. Previous government programs attempted to aid those who are behind on their mortgage payments. The FHA Short Refi is targeted to borrowers who are current and can afford their payments, borrowers who could not qualify for the different loan modification programs available.
FHA Short Refinance Requirements
The FHA Short Refinance program has a lot of restrictions. In order to qualify for the program a borrower must:
- Be up-to-date on the payments for the current mortgage
- Be in a negative equity position
- Live in the property as the primary residence
- Have a current loan that is NOT an FHA guaranteed loan
- Meet FHA qualifying rules for debt-to-income ratio
- Have a credit score of over 500
- Receive at least a 10% reduction in the principal balance from the current lender
- Not exceed a loan-to-value of 97.75% on the new FHA loan
Requirements for Properties With Second Mortgages
Properties with second loans or home equity lines of credit (HELOC) have additional restrictions:
- Any second loan must agree to be subordinated
- If the borrower has a second mortgage the combined loan-to-value can reach 115%.
- The second loan cannot call for a balloon repayment, for a minimum of 10 years, unless the property is sold or refinanced.
Previous Loan Modification is Not a Barrier
Even if you have gone through a loan modification, you may qualify for the new FHA Short Refinance program. If you went through the Making Homes Affordable Program, you may be eligible for the new FHA program in the month after the loan modification was made permanent. A three month on-time payment history is required for eligibility if you had a loan modification outside of the Making Homes Affordable Program. In fact, the new FHA Short Refi may be an ideal way for someone who has completed a loan modification to further improve his or her financial position.
FHA Short Refinance Negatives
Potential negative effects of the program include an FHA requirement to purchase mortgage insurance, closing costs for the new loan, and the chance that a lender can report a reduction in the principal balance to the credit bureaus, harming the borrower’s credit score.
The biggest negative is that most lenders have chosen not to participate in the program, leading to borrower frustration and anger.
The FHA Short Refinance option is aimed at homeowners that are current on their mortgage payments and who suffered substantial depreciation in the value of their homes. Borrowers must secure a principal reduction from their lenders of at least 10%. If your home is underwater and you would benefit from lowering your current interest rate, it is worthwhile to consider this program. Separately, even if you have a good interest, if you can get your lender to agree to reduce your principal balance, the program may benefit you strongly.
The FHA Short Refi program requires the banks or investors who own the loans to voluntarily reduce the principal. The theory is that the lenders have an incentive to do so. The banks or investors remove the potentially problematic loan from their portfolio, the number of people underwater in their mortgage is reduced, and the homeowner remains in the property. This leads to stability in the housing market, reducing the pressure of a continuing downward spiral fed by foreclosures. Still, because it is voluntary, it is not clear how many lenders are going to participate. Many financial experts are concerned that this program will have a much narrower reach than intended, just as the previous government efforts to help borrowers have not been very effective at aiding many of the people who need help.
Lenders have not yet decided how and to what level they are going to participate, so if you speak to your lender, do not be surprised if they say that they have no formal policy in place. If that happens to you, maintain regular contact with your lender. Check with your lender regularly to see if a refinance option may be available to you, either through the FHA Short Refi program or through another loan your lender may offer.
In the first two options you will need the approval of the second mortgage holder. I understand that maintaining good credit is important, as you want to buy and finance another property.
Consider the costs of renting out the property. Will the rental cover the mortgage payments? IF you must move for job reasons, then contact your lender and try to negotiate a short sale and payment plan for the balance. Check to see if you loans are non-recourse loans.