Understanding Principal Reduction for Underwater Mortgages

Written by: Scott Sery

Part of the American dream is to be a homeowner.  As housing sales and prices have slumped over the last few years, many homeowners found they owed more on their homes than the house was actually worth, in other words, their mortgage was underwater.  Having an underwater mortgage greatly complicates selling or refinancing a house to take advantage of lower interest rates.  In many cases, homeowners with underwater mortgages have simply mailed the keys back to the mortgage lender and walked away and allowed the house to be foreclosed.  This seems like the easiest option, but it can result in a 200 to 300 point reduction on their FICO score.  With that big of a hit there is little chance they will be able to finance anything in the near future.

Since the start of the housing crisis, Congress has been working on a way to help those who face an imminent foreclosure with programs like the Principal Reduction Alternative of the Making Home Affordable program.  Even if a homeowner finds they are underwater with their mortgage, as long as they are still making payments, they have options.  The Principal Reduction Alternative will allow the person to work closely with their bank to eliminate the negative equity by reducing a mortgage to the amount of the appraised value of the house.  This program is not for everybody as there are strict eligibility requirements a person must meet before they can be considered.

One benefit of the PRA program is obviously to the homeowner.  The bank writes off some of the principal on the loan in hopes that the homeowner will stick around and keep making their payments.  This is why even one missing document can cause the homeowner to start completely over in the application process.  Banks do not want to take a hit, but they would rather write off part of the loan, than go through the expense and hassle of taking the property through foreclosure.  While there are a great number of good aspects to the program, many people, such as James R. Hagerty from the Wall Street Journal feel the program could actually end up causing more foreclosures than it will prevent.

Another benefit of the PRA program is to the lenders.  Banks are not in the real estate business.  By taking foreclosing on a property, banks end up are forced to sell an empty house in a slow housing market while paying all the maintenance and upkeep costs until it can be sold.  Banks can financial incentives to help a homeowner stay in their house through principal reduction.  In many cases, the write-off from a principal reduction is smaller than the total expense of the foreclosure process.

Through the PRA program, or an FHA short refinance, or one of the many other options available through MakingHomeAffordable.gov, people have options.  These programs give those who feel their home is no longer affordable options other than foreclosure for dealing with an underwater mortgage.


Understanding Principal Reduction for Underwater...

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