Refinancing Your Mortgage When You're Underwater on Your Loan

With the steep drops in home values in recent years, many homeowners who would like to refinance their mortgage to take advantage of the dirt cheap interest rates now available have been unable to do so, because they owe more than their property is worth. But now they have an option.

Recent changes to the government’s Home Affordable Refinance plan now allow homeowners to refinance their mortgage at up to 125 percent of the home’s current value. The change allows homeowners who are “underwater” on their mortgage and have good credit to refinance into a more affordable loan.

If you have an adjustable rate mortgage that’s scheduled to reset to a dramatically higher rate or will have to make a large balloon payment, the program may be your best shot at restructuring your loan if you owe more than the property is worth. For a conventional refinance, most lenders these days require you to have at least some equity in the property, ideally at least 20 percent. Having “negative equity” makes it virtually impossible.

Begun in April, the program originally was limited to refinancing up to 105 of the current assessed value of a property. But because so many homes across the country have lost so much value in the current housing downturn, relatively few at-risk homeowners were able to take advantage of it. While homeowners who still had equity in their property flocked to conventional refinancing programs in recent months, drawn by historically low rates, those with “negative equity” due to declining home values had few options.

The new 125 percent loan-to-value limit should open up the program to a lot more homeowners and provide an option to those who are “underwater” on their loans. Although home values have dropped by as much as 50 percent in some hard-hit housing markets such as Miami and Las Vegas, the vast majority of the country has seen more modest declines. In the majority of U.S. housing markets, a 125 percent loan-to-value limit should be within the reach of most homeowners who did not take out extensive home equity loans on top of their mortgage.

To qualify, you have to have a loan that is backed by either Fannie Mae or Freddie Mac, the two major government-supported secondary lenders that back the vast majority of U.S. mortgages. If your mortgage is held by Fannie Mae, you can refinance with any participating lender. If you’ve got a Freddie Mac mortgage, your options are a bit more limited, as you can only refinance with the same lender you currently have.

The Home Affordable Refinance plan is the less well-known companion to the government’s loan modification option under the Making Home Affordable Program, a federal initiative to help homeowners restructure their mortgages to avoid foreclosure. Generally, the loan modification program is designed for people who have fallen behind on their mortgage, while the refinance program is for people who are current, but could get into trouble down the road if they can’t reduce their mortgage costs or avert a scheduled increase in payments.

To date, both programs have had their struggles since being launched in April. The government recently announced that only 93,000 mortgages had been refinanced under the program so far, out of a projected 5 million the government expected over two years. It remains to be seen, however, whether raising the loan to value limit to 125 percent will make a significant difference.

More information on the program, including qualification guidelines and assistance in identifying if you have a Fannie Mae or Freddie Mac mortgage, is available on the Making Home Affordable web site at http://makinghomeaffordable.gov.

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