How to Refinance a Mortgage That’s Underwater

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Refinance Mortgage

Photo: 401(K) 2013

If you’re underwater on your home – meaning you owe more than your home is worth – you’re certainly not alone. Many American families are in the same situation because of the real estate market crash. Even though property prices are starting to rise in some areas of the country, many families are still in this situation.

Unfortunately, being underwater on your mortgage, or having less than 20 percent equity in your home, can make refinancing difficult. But the government has several programs to help borrowers take advantage of the current low mortgage rates or avoid foreclosure by lowering their monthly mortgage payments.

If you’re underwater on your mortgage, take these steps to try to refinance your home:

Look into a new appraisal

If you’ve had your home appraised to start the refinancing process, you may have been surprised to find that your home appraised for less than you think it’s worth. Home appraisals are generally thorough and based on standard forms. But there’s room for subjectivity and fluctuation, depending on your appraiser.

So if you feel that your appraisal set your home’s value too low, put your best foot forward with a new appraisal. It may cost you $200-$500, but if you save a fortune with a refinance, the money could be worth it.

This is an especially good option if a few thousand dollars in appraised value would make a big difference in your ability to refinance.

Check out government programs

If you’re underwater on your home, or if you don’t have much equity, you should start by checking out government-backed programs. There are several options, including HARP, the FHA streamline refinance program, and HAMP.

Here are the basics of these programs, which can all be used to refinance your mortgage or, at the very least, lower your payments for a set period of time:

HARP: Home Affordable Refinance Program

HARP is great if you’re underwater on your loan but not behind on your mortgage payments. To qualify for this refinance, you’ll need to meet several requirements, including being current on your mortgage. Your loan also needs to be owned or backed by Freddie Mac or Fannie Mae.

You can find the full list of requirements on the official HARP site.

If you meet all these requirements, you’ll be able to work with your current lender – or a new lender approved by Fannie Mae or Freddie Mac – to take advantage of lower costs and mortgage rates. The process is similar to a regular refinance, with the difference being that homeowners with low or no equity are eligible.

FHA Streamline Refinance

If you have an FHA-backed mortgage, the streamline refinance program may be a good option for you. This type of refinance doesn’t require an appraisal, but is based on the price that you bought the home for. This means that if your home’s value has fallen because of market conditions, an FHA streamline may help you get a lower-interest mortgage.

You cannot do a cash out refinance with an FHA streamline, and the refinance will have to lower your monthly principle and interest payments by around 5 percent or more. You can also use this option to convert your adjustable rate mortgage to a fixed-rate mortgage.

One advantage of a streamline refinance is that you may not need cash on hand for the closing costs. There will be closing costs, but they can be rolled into your loan and paid off month by month.

FHA Refinance for Borrowers with Negative Equity (FHA Short Refinance)

This program is a good one if you’re only a bit underwater on your home, but it may or may not work for you. Basically, you’ll take your non-FHA loan and refinance it as an FHA-insured loan. However, you have to work with your current lender, and the lender has to agree to knock the principle on your first mortgage down to no more than 97.75 percent of your home’s current value.

An FHA Short Refinance will take more paperwork than a streamline refinance, but it can be a great option if you’re underwater on your home. Find out more about requirements for this program here.

HAMP: Home Affordable Modification Program

HAMP isn’t technically a refinancing program, it’s a loan modification program, but it can be used to lower your mortgage payments. The program is meant for struggling homeowners who may lose their homes without a lowered payment.

In June 2012, the program was extended to include more homeowners. Before that, you had to be an owner-occupant and have a 31 percent or lower debt-to-income ratio. Now, you can apply for HAMP on a home that you rent out or plan to rent out and, possibly, if your debt-to-income ratio is greater than 31 percent.

Essentially, HAMP can lower your monthly mortgage payments for a set period of time – usually up to 60 months – while you get back on your feet financially.

Principle Reduction Alternative (PRA)

Again, this program isn’t technically a refinance, but it has some similar effects. If you’re underwater on your home by a huge amount, this program can help encourage your lender to reduce the amount you owe on your home.

You’ll have to prove that you have encountered financial hardship, but that you can still pay the new, modified payment after the principle is reduced.

Why would a mortgage lender reduce your principle? Let’s say you owe $300,000 on a home that’s now worth $250,000. If your lender has to foreclose on you, they probably won’t get the full $250,000 after the costs of selling it, etc. They’ll be out at least $75,000 or more.

But if they knock $50,000 off your loan, they stand a chance of getting back the $250,000, plus interest. Not all mortgage lenders will take this chance, but many will, especially with a government-backed program.

Not sure which, if any, of these programs would work for you? Check out HUD counselors in your area to get some advice on your best options.

Consider taking out two loans

If you’re not underwater by much and have good credit, one option might be to take out two loans – a first mortgage for the bulk of the value of your home, and a higher-interest second mortgage or home equity line of credit. The second loan will be easier to pay off because it will be smaller, even though it will have a higher interest rate.

This option lets you use the higher-interest second mortgage as a down payment of sorts on a refinance. You can then get a much lower interest rate on the main mortgage through a refinance, which may lower your total monthly payments altogether.

Communicate with your lender

Finally, even if you aren’t eligible for a government program, it’s important to communicate with your lender as early as possible. If you’re having trouble making mortgage payments, or if you’re keen to take advantage of today’s low interest rates, ask your lender about the options available to you.

Again, it’s usually to a lender’s advantage to work with you, rather than foreclosing on you. But you’ll need to start the conversation well before the foreclosure process begins – preferably before you miss a mortgage payment.

If your mortgage is underwater, refinancing can be difficult. But being able to stay in your home or take advantage of today’s mortgage interest rates makes it worth the effort.

Published or Updated: April 23, 2013
About Rob Berger

Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

Comments

  1. Lynda says:

    After trying to get a refinance of our mortgage for 3 years through BOA, we were recently able to do it with absolutely no hassle through Quicken. We were underwater on our loan, and because we have been renovating our home, an appraisal was impossible. Do not go through a conference sponsored by NAACA, advertised by news media as great ways to get much lower interest rates or loan reductions. Because of that process, BOA told us we should be paying more than we were and they initiated foreclosure threats even though we have never missed a payment with them or had a late payment! They initiated a drive-by inspection which cost us $80, to make sure we were keeping our property in good order. It took over 6 months to get off their foreclosure list!

    I found out the details about the HARP refinancing and BOA wanted nothing to do with it. It took one call to Quicken and the refinancing process was fast, easy and efficient.

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