Starting Sept. 7, 2010, underwater homeowners have a new option for refinancing their mortgages. The question is, how many will be able to take advantage of it?

The FHA's Short Refinance Program allows underwater homeowners - those who owe more on their mortgage than their home is worth - to refinance into an FHA-backed mortgage at a lower rate. To qualify, borrowers must presently have a non-FHA mortgage and be current on their mortgage payments.

10 percent markdown required

The main catch is that the existing lender must agree to write off at least 10 percent of the loan principal on the primary mortgage. It's not clear how many lenders will be willing to do that, particularly since the government isn't offering any incentives for them to do so.

Some lenders may find it preferable to simply wash their hands of risky loans by handing them off to the FHA at a 10 percent discount, rather than risk a bigger loss should the loans eventually go into foreclosure. At the same time, requiring that borrowers be current on their payments means the program is only open to homeowners who are less likely to default in the first place.

In addition, the new, refinanced FHA mortgage cannot exceed 97.5 percent of the current value of the home. Most underwater homeowners would need their lenders to write off considerably more than 10 percent of their mortgage principal to reach that standard - many are underwater by 20, 30, 40 percent or more.

May help those with second mortgages

One group that may be helped by the new program is homeowners with secondary mortgages. Many of them may have a primary mortgage that is only slightly underwater, while the second mortgage is no longer backed by any equity in the home.

In that case, a relatively small reduction in principal on the primary loan may be enough to bring it below the FHA's 97.5 percent limit, while the second mortgage remains in place. The total of all mortgages after refinancing cannot exceed 115 percent of the home's value and the second mortgage (and any others) must be resubordinated to the new FHA loan.

The program also includes incentives of up to $500 for lenders who opt to reduce the balance owed on secondary mortgages.

Optional program for lenders

The program is a voluntary one for lenders, so it's up to them whether they choose to refinance any particular loan or not. If approved, borrowers will need to pay FHA mortgage fees and will likely take a hit on their credit score from their lender writing off part of their debt.

For more information, read the FHA mortgagee letter providing guidance on the program to lenders. Homeowners interested in applying should contact their mortgage servicer.

    Published on September 7, 2010