Homeowners, who are slipping on their mortgage payments and unable to change their financial position, may feel like they are in a dead-end spiral and have no option but to walk away or resort to a short sale. But brokers say that it is possible for underwater homeowners with adjustable-rate mortgages to obtain something called a short refinance.
A short refinance is usually when a homeowner negotiates a short payoff with their lender and then gets a new government-subsidized loan through the Federal Housing Authority (FHA) for a lower amount.
With stricter lending practices, most agree that traditional refinancing routes are difficult for those behind on their mortgage payments. One of the main challenges is seeing if your lender will agree to a short payoff, who when agreeing, generally accept 95 percent of your home's current appraised value, says Justin McHood, a mortgage commentator with Zillow.com.
- "This is the biggest secret that people aren't talking about," McHood says.
McHood adds that whether lenders will accept a short refi or not is determined on a case-by-case basis and depends on your individual mortgage. He says the first step is to call up your lender directly (such requests are usually funneled through the Loss Mitigation department) and inquire.
Next, homeowners can qualify for a fixed-rate FHA loan for a loan-to-value ratio of up to 97.5 percent of the home's current value.
For example, if you have a mortgage for $200,000 and the value of your home has fallen to $150,000, your bank could accept a short payoff negotiation of $142,500. Through FHA, you could then be approved for a new loan of $146,250, or up to 97.5 percent of $150,000.
One of the biggest advantages on top of getting out of an unsustainable home payment plan is being able to switch from an adjustable-rate mortgage to a fixed payment plan, offering lower, more predictable interest rates in the future, brokers say.
"If they can get from a non-conforming adjustable rate to a fixed rate of a FHA loan, that will be a cheaper rate," said Tom Vanderwell, a mortgage lender and author at the blog straighttalkaboutmortgages.com. "[Borrowers] can make their payments and save their house."
But the uphill battle is being able to meet FHA guidelines and paying the higher upfront fees required by the government-subsidized loan. Homeowners need to own a single family home, which excludes condos or town homes, have good credit (brokers recommend above 620) and be current on mortgage payments within the last two years.
Another sticking point is the high upfront fees that are associated with the FHA loan. There's a 2.25 percent FHA insurance fee, which brokers liken to a private mortgage insurance (PMI), and an additional fee of at least another 1.25 percent.
Vanderwell says this cost tacked on to the current interest rate--somewhere around 4 to 5 percent -- may be higher than a conventional mortgage. But the problem is that private lenders who would accept that amount of loan-to-value, or absorb the risk, are scarce, and for some, the only option is a government-secured loan.
McHood agrees that a short refinance isn't a perfect solution either, but for underwater borrowers wanting to stay in their homes, it should be a first consideration before a strategic default or a short sale. "What you are really combating is negative equity," he says. "Homeowners are trying to make the decision of whether to stay or not."