Underwater refinancing with Uncle Sam's help

Posted by  on Jun 01, 2012

For homeowners owing more on their mortgage than their homes were worth, the debut last fall of the Federal Housing Administration's (FHA) Short Refinance program seemed like a lifeline. The Short Refinance program's objective was to help housing markets recovery by averting strategic defaults (homeowners walking away from underwater homes) and decreasing foreclosures.

How the Short Refinance program was meant to help

Under the FHA Short Refinance program, homeowners who qualify are allowed to refinance their mortgages to new FHA loans. Not only that, but this home refinance program also cuts principal balances to less than the home's value.

For borrowers meeting eligibility criteria--including being current on their mortgage payments, having documented income and a credit score of 500 or better to qualify for the new loan--the FHA Short Refinance program seemed a promising way to get out from under an underwater situation.

The U.S. Department of Housing and Urban Development (HUD) had estimated that between half a million and 1.5 million homeowners could be helped with this program.

Few homeowners have seen benefits

Those borrowers who refinanced through the program have received substantial benefits, but how successful has the FHA Short Refinance program been at scale? Unfortunately, nowhere near as many homeowners as HUD had hoped.

The numbers released by the FHA are not encouraging: Nearly a year after its deployment, the FHA Short Refinance mortgage has failed to reach most of those it was created to help:

  • As of the end of August, 27 lenders (including GMAC Mortgage and Wells Fargo) are participating in the program, but notable by their absence are Fannie Mae and Freddie Mac. HUD has characterized lender participation as "disappointing."
  • A whopping 301 home refinances have closed under the FHA Short Refinance program, and 870 applications are in process.

In March 2011, the House of Representatives voted to kill the FHA Short Refinance program, and the program's future is uncertain.

An alternative for underwater borrowers

The odds of getting a principal reduction on your underwater mortgage through the Short Refinance program are extremely low. However, another program has flown almost completely under the radar and has enjoyed significantly more success than the FHA Short Refinance. It's called the Principal Reduction Alternative, or PRA.

PRA is an offshoot of the Home Affordable Modification Program (HAMP). The Treasury Department pays incentives for mortgage servicers to make principal reductions when a borrower has an eligible mortgage with a loan-to-value ratio of 115 percent or greater.

As of August 2011, 10,544 PRA modifications have been completed. The median principal amount reduced is $67,850, or 30 percent of the original loan amount.

Who's eligible for principal reduction

If you meet HAMP eligibility guidelines and your loan is not owned or guaranteed by FHA/VA, Freddie Mac or Fannie Mae, you can apply for a PRA modification.

Why are mortgage lenders willing to grant 30 percent principal reductions through PRA while balking at FHA Short Refinance principal reductions on the order of 10 percent? Probably because HAMP applicants must be at risk of "imminent default," whereas Short Refinance applicants are current on their mortgages.

Unlike with the FHA Short Refinance program, the list of participating lenders for PRA is quite long, more than 100 lenders. The largest participants include Bank of America, CitiMortgage, JPMorgan Chase and Wells Fargo. The government's MakingHome Affordable.gov site has more details.


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