refinance

Refinance help for underwater homeowners

Highlights
  • Homeowners can get a new loan up to 97.75 percent of the home's value.
  • The lender must write off at least 10 percent of the principal.
  • Income documentation, closing costs and mortgage insurance are required.

Underwater homeowners may be able to refinance into a loan insured by the Federal Housing Administration, or FHA, and get rid of some of debt -- but only if their lenders agree.

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The federal government has announced adjustments to FHA programs intended to increase the number of qualifying mortgages "responsibly restructured and refinanced into FHA loans as long as the borrower is current on the mortgage and the lender reduces the amount owned ... by at least 10 percent," according to congressional testimony by Phyllis Caldwell, chief homeownership preservation officer at the U.S. Treasury Department.

The program is aimed at homeowners who owe more than their homes are worth -- so-called "underwater" homeowners -- and differs significantly from the Home Affordable Refinance Program started up about a year ago. The new guidelines differ from HARP in that they:

  • Involve the FHA. By contrast, HARP is focused on loans owned or guaranteed by Fannie Mae and Freddie Mac.
  • Offer lenders incentives to reduce principal. HARP specifically prohibits any reduction in the borrower's loan balance
  • Allow a maximum loan-to-value ratio of 97.75 percent. HARP allows an LTV up to 125 percent.
To qualify for the new program, homeowners must:
  • Occupy the home as a principal residence.
  • Have a FICO score of at least 500.
  • Submit income documentation.
  • Meet other FHA refinancing guidelines.
  • Pay an appraisal fee and closing costs.
  • Pay FHA mortgage insurance premiums.

Borrowers must be current on the existing loan. This requirement is intended to discourage so-called "strategic defaults," in which a homeowner purposefully skips mortgage payments to try to get a loan modification.

Homeowners who already have an FHA-insured loan are excluded because the FHA is prohibited by law from principal reduction.

The caveats

The program may be most attractive to homeowners who don't have a second home loan. That's because details have yet to be announced about a plan to write down second loans so the borrower's total mortgage debt won't be more than 115 percent of the home's value. Whether lenders will cooperate is uncertain.

Homeowners also should be aware that forgiveness of mortgage debt can trigger federal or state income tax liability.

The federal tax code has an exclusion for up to $2 million of forgiven mortgage debt used to purchase, construct or improve the home, according to Mark Luscombe, principal federal tax analyst at CCH, a tax information services and software company in Riverwoods, Ill. Taxpayers who are insolvent also may be able to exclude forgiven mortgage debt from income.

Most states conform to the federal rules, but there are some exceptions, according to CCH spokesman Neil Allen. Forgiven mortgage debt is taxable income in Kentucky, Massachusetts, Mississippi and Wisconsin. Other states that also have taken different approaches are Arkansas, California, New Jersey and Pennsylvania.

Debt forgiveness is typically reported as a negative item on the borrower's credit history.

The program is voluntary for lenders. That means if the lender says no, the homeowner can't refinance into the FHA loan, even if he or she meets the other requirements.

To learn more about the program, visit the government's Making Home Affordable website.

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