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Negative Equity Refinancing Instead of Foreclosure

Negative Equity Refinancing Instead of Foreclosure
Daniel Cohen
UpdatedDec 1, 2010
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    6 min read
Key Takeaways:
  • 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:

  1. Refinancing with your current lender
  2. 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.


LLu, Feb, 2013
I have an FHA mortgage and I'm current on payments, but I am underwater on it. I've been researching for programs (other than the FHA Streamline) that can help me refinance, forgive the difference between what I owe and what it's worth (like the HARP program) thus allowing me to keep my home, but I cannot find any. The Streamline will reduce my rate by 1.25% but the FHA mortgage insurance premium will add as much money to the new loan amt. as I would be saving, making no real impact on my payment and still leaving me underwater; plus, I'd have to start my 30 yr. mtg. over. At my age, it's not worth it. Does anyone know if there's any help out there for FHA mortgage holders who are underwater but current? THANK YOU!
BBill, Feb, 2013
The FHA streamline is the only program that is designed for underwater FHA borrowers. The principal forgiveness program that was released, the FHA Short Refinance program, required that your current loan was not an FHA loan. Unless there is a new program that is released, some variation of a HARP 3.0, I think the FHA streamline will be your only option. I understand that does not make sense to do, because the reduction in interest rate is offset by the cost of mortgage insurance, as you explained.
TTammy, Oct, 2012
We presently have both first and second (home equity) loans on the home we purchased in 2007. Neither loan are FHA or backed by Freddie or Fannie. Both loans are interest only for another five years. Though my husband and I both have stable incomes, state employees, we have had our hours and pay cut in the last couple years. We have taken on extra duties to keep making the payments but holding on is becoming harder. We do not want to lost this home and start over. If we were younger maybe but we are approaching retirement age though we may never see it. We have also accrued credit card debt to stay afloat. A couple of months I found out about the FHA Short Refi but worry qualifying for so many reasons. We live in a state that has seen the largest drop in home values so we are definately upside down. Mainly due to the fact that we have both loans. I called my provider, SPS, and they told me that they were not participating in the program because they were not a bank. I couldn't get anything out of them about the principal reducation either. We have been trying to pay down our credit card debt so we can qualify for the refi so I have waited to apply. I am afraid I am runninig out of time however. How long before this program ends? Should we consider another option?
BBill, Oct, 2012
Tammy, if your lender is not willing to reduce your principal balance, then an FHA Short Refi is not an option. Have you tried speaking to your lender about a loan modification?
LLisa, Jun, 2012
We have a mortgage that BoA bought from Countrywide a few years back. We owe 76K and the homes in this neighborhood are now selling for 45 - 50K. There's no way our home will sell for that, as it needs electrical and plumbing work. We are behind 2 months and have been working with their assistance dept, but just got a letter from them saying they have discontinued the assistance because we never submitted the required paperwork, even though we faxed it as required, TWICE. We filed Ch 7 when my husband was out of work in 2004, and we were behind on the payments by 1 month from that point on, even after he returned to work. Then we had an emergency come up a few months ago and became behind by 2 months, which started this current mess. This is an FHA loan and BoA isn't doing the short refi program, so we don't know if there is anything else available to us.
BBill, Jun, 2012
Consult with a lawyer immediately to discuss your options. It is unconscionable for Bank of America to disqualify you from its assistance programs for the excuse of not providing any documentation when you gave Bank of America the documentation it asked for more than once.
rricky, Apr, 2012
I'm wanting to sell my house (currently on the market) and have it priced at 198k (I can't go below 190k so that I can clear realtor commissions and also have some left over for DP on new property). The homes in my neighborhood are selling for way less- my next door neighbors house is listed at 158k and they are under contract. I know that 1- my home isn't going to sell for what I need and 2- it will never appraise for that. I'm stuck!! My first mtg is FHA with Bank of America and also have a second with BOA. I currently owe $175,000 total. Never late on payments. It doesn't look like most of the programs are available for FHA loans... are there any options for me that wont effect my credit negatively and that can reduce my principal. Refinancing doesn't seem like it would be worth it since I am moving (or at least trying to)! Thanks
BBill, Apr, 2012
If you want to sell your house, and not be left with a deficiency balance, then you will need to wait for the market to pick up again. Your other options are to: 1. Do a Short Sale 2. FHA streamline finance making the payments more affordable. 3. Keep making the payments on your loan.

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.

CCandace, Apr, 2012
Bill,We are current on our VA loan for our home in WA through Wells Fargo. It is our primary and only residence. We currently owe $184k but the home is appraising at $158k. Our credit scores are in the low to mid 600s. Would Negative Equity Refinancing be an advisable option for us? What are the negatives? Ideally, we would like to sell sooner than later without taking a hit to our credit, as my husband may be medically retired/discharged within a year and we will be moving.Sincerely,Feeling Trapped
BBill, Apr, 2012
A Va streamline loan would be your only possibility, although the lender may require an appraisal report, that will make the refinance not a viable option. In any case, refinancing for a short period, is generally not worthwhile. I recommend that you speak with lenders and then check the economics of a refinance. Also, start to research the implications of selling your home for less than it is worth. Start by speaking with the VA for more information.