Until recently, it took a rare combination of extreme bad luck and poor judgment for a homeowner to end up under water on his mortgage – that is, owing more than the house is worth. Today, nearly one out of four homeowners is facing exactly that situation. In response, banks and the government are rolling out new programs they say will help – that is, for homeowners who qualify.
After banks' initial resistance to loan modification programs and refinancing designed to help struggling borrowers, many are now embracing programs for homeowners in trouble. Both GMAC Mortgage and Wells Fargo have started either reducing some mortgage balances, deferring payments or offering subsidized refinancing. Chase says it will open another 30 dedicated "help centers" this year where homeowners can apply for loan modifications. This month, the government also stepped in, extending the period for underwater borrowers to refinance their mortgages at lower rates, which was not possible through standard refinance programs. "All of a sudden, everyone is aware of this growing problem," says Stu Feldstein, president at SMR Research, which tracks the mortgage market.
About a year ago, it seemed the number of underwater homeowners was declining as home prices were rising. But housing analysts say that trend is now reversing. Approximately 23% of homeowners with a mortgage are underwater -- near an all-time high -- according to fourth quarter 2010 data from CoreLogic, a mortgage-data firm. That figure rose for the first time in a year, and it's up from 22.5% in the previous quarter. Meanwhile, another 2.4 million homeowners are teetering on the brink, with less than 5% equity in their home. If home prices drop another 10% -- which is likely over the next year – many of those owners could end up with negative equity, says Cameron Findlay, chief economist at LendingTree.com.
While this has been an obvious problem since 2008, "large banks have been extraordinarily slow to move to adopt these programs," says Paul Leonard, a director at the Center for Responsible Lending. But now lenders are increasingly stepping in, eager to avoid foreclosures, which can cost the bank far more than a reduced payment plan or loan modification ever would. Lenders are also hoping to keep discouraged homeowners from intentionally walking away from their home: Half of homeowners who owe 50% or more on their home than it's worth and who default do so strictly because of negative equity, according to a 2010 Federal Reserve Board study.
But the banks' programs aren't designed simply for people disappointed by falling prices. To qualify, in most cases, borrowers have to prove they're having trouble making their payments and for a good reason. They'll often have to provide documentation for a job loss, a pay cut, large medical expenses or other unanticipated losses. If approved, they could be offered a lower interest rate – by up to 2%lower when a bank is participating in the government's Home Affordable Modification Program. Or they may also receive a longer repayment period – extending a mortgage up to 40 years from the date of origination -- which makes monthly payments smaller, says Leonard.
With some lenders, borrowers who are past due and whose home values have suffered large losses (and appear unlikely to recover in the near term) could qualify for a principal deferment, where a chunk of the mortgage is set aside to be paid later, or out-and-out forgiveness of part of the loan. In general, borrowers will have to meet some income limitations. Modifications typically occur when a borrower's monthly mortgage payment is more than 31% of their monthly household pre-tax income and when the principal balance is no more than $729,750 on a single-family home. The amount forgiven is often small in the grand scheme of things, and it varies depending on the lender and the borrower's circumstances. Wells Fargo, for example, says it eliminated $51,000 in principal, on average, for more than 73,000 borrowers from 2009 through 2010.
Some government programs offer help, through refinancing, to underwater borrowers who are capable of making payments. But applicants will need to meet a long list of qualifications. For underwater borrowers, these programs are among the very few options available for them to refinance. Homeowners who owe up 125% of their home's current market value should contact their lender or mortgage servicer to find out if they're participating in the government's Home Affordable Refinance Program (HARP), which was just extended through June 2012. Borrowers must have a mortgage that's guaranteed by Fannie Mae or Freddie Mac -- to find out, contact these agencies or your mortgage company -- be current on their payments, and not be more than a month late making a payment over the past year.
There's also an option for borrowers who are even further underwater where participating lenders must agree to write off at least 10% of their unpaid principal balance on their primary mortgage. Since September, the government's Federal Housing Administration has been offering some underwater borrowers in areas with large declines in home values -- like Miami and Las Vegas -- a chance to refinance. But that's assuming that their lender agrees to write off a portion of the unpaid principal and that the borrower doesn't have an FHA mortgage but can now qualify for one. So far, just 24 lenders are participating, and only 99 loans have been approved, according to an FHA spokesman. A GMAC spokeswoman says the company will open up this program to some of its borrowers in the next few weeks.
In spite of the recent flurry of activity, consumer advocates say homeowners shouldn't expect much – at least not yet. As it is, some government programs have already fallen short of expectations. HAMP, for example, has helped around 600,000 people permanently modify their mortgages since 2009 -- so far, a far cry from the up to four million it was projected to help. And banks have been slow to act as well, especially when it comes to borrowers who are currently making payments. Among lenders "there is some concern that by offering [principal reduction] qualified borrowers will storm the gate and demand a reduction," Leonard says. So far, that hasn't been the case. From 2009 through 2010, Chase says it helped around 500,000 borrowers avoid foreclosure. During that period, about two million foreclosures occurred, according to RealtyTrac.com. And critics say even the loan modifications that have been in place haven't helped that much: Many of those borrowers fell behind on payments again afterwards.
Of course, there are other options for desperate homeowners. They can try a short sale, assuming the bank allows them to sell the home for less than what's owed on the mortgage. More lenders are now open to this, says Stuart Gabriel, director at UCLA's Ziman Center for Real Estate, because they're likely to lose less money in a short sale than they would in a foreclosure. Or, if they can make the payments, they can decide to ride it out. Contrary to popular belief, homeowners who have seen their homes lose 25% or more in value but can afford to keep paying the mortgage might be better off staying there and waiting for prices to stabilize, says Findlay. But if a borrower is able to refinance into a lower rate through a government program, that might be the better move, he says.