Today the newest FHA program to refinance borrowers who owe more on their home than the property is actually worth went into effect. This new program, made possible under the Emergency Economic Stabilization Act, will be available to homeowners starting today and lasting through December of 2012.
The impetus behind this new rule is to allow homeowners who are underwater because of dropping values to refinance into a lower interest rate so that they can better afford the payment. The existing mortgage holder has to agree to voluntarily reduce the principal balance of the existing mortgage 10%, and then the borrower can refinance into an FHA loan up to 97.75% of the home's value. If the borrower has a second lien, the second lien can stay in place for total loans of up to 115% of the home's value. Notice that the principal reduction is voluntary on the part of the the current mortgage company, so if they do not agree to take a 10% write down on the loan, the borrower is out of luck.
The program has some other interesting caveats. For instance, it cannot be used to refinance an existing FHA loan, so if the borrower is upside down with FHA, he is still out of luck. Also, the homeowner must be current on his house payment and must have a credit score of at least 500. The loan may be a loan that was previously modified under Making Home Affordable but other than that it cannot have been delinquent and caught up by the servicer. Loans that are in the HAMP trial period are not eligible for this refinance--FHA really wants to weed out dog loans on this program, so they require that you must be current on the house payment up until the month that the new refinanced loan closes.
The program also requires that other credit be acceptable. According to HUD, major negative credit such as judgments or collections or other recent credit problems must be explained by the borrower and the explanation must be satisfactory to the lender.
HUD also wants to remind us that a short refinance in which the principal balance of the loan is reduced by 10% may negatively impact the credit score of the borrower as it may be reported as a short refinance. Further, the borrower should consult with a tax preparer because he may have to pay taxes on the amount of the debt forgiveness since as far as the IRS is concerned, this could be considered income. To put that into perspective, if you owe $400,000 on your home and you have your principal reduced 10% on your mortgage by your current lien holder, that is $40,000 in debt forgiveness which could potentially be added to your income for income tax purposes.
HUD estimates that between 500,000 and 1,500,000 borrowers will refinance on this new program. And that figure may be true. What HUD is not saying is that the Making Home Affordable Program, which is the stepmother of FHA's new program, has given trial modifications to about 1.3 million borrowers so far. The trial modifications last three or four months. But of those 1.3 million, nearly 600,000 homeowners have dropped out of the program because they could not make their house payments, and another 250,000 are still waiting to see if they will qualify for modification. An August 27 article in Daily Finance cites a Barclay's Bank study that 60% of homeowners who complete the Making Home Affordable Program and refinance their homes will ultimately go back into default. The reason--they simply cannot afford the houses in the first place.
The problem is so serious that Daily Finance referred to the Making Home Affordable Program as "Real Estate Mortuary's Waiting Room," because the loans that are in HAMP are going to eventually end up in foreclosure.
HUD is hoping that the new FHA refinance will be more effective and more promising. But with unemployment still high and sales dropping, another program to try to fix everything by lowering the house payments of homeowners who cannot afford their homes may just be a lot of hype after all.
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