In an effort to help responsible homeowners who owe more on their mortgage than their home is worth, the government recently announced an FHA Short Refinance Option. This program would allow underwater homeowners to refinance and get at least 10% of their mortgage forgiven permanently. There are some qualification requirements, but those who qualify could take advantage of the program to reduce their mortgage debt.
An option that has been available for sometime as an alternative to foreclosure has been a short sale. In a typical short sale scenario, the homeowner is in danger of foreclosure and finds a willing buyer for his home. The problem that usually arises is that the buyer isn't willing to pay enough for the home to payoff the current mortgage. In these situations, a lender may be willing to take less and write off the balance to avoid taking the property back at a sheriff's sale. The advantage for the homeowner is that the bank also agrees not to pursue a deficiency judgment against him. The short sale, however, still usually results in an adverse impact on the homeowner's credit rating.
The "short refinance" allows the homeowner to keep his home by getting the bank to agree to allow him to refinance and accept less than the full balance due as a complete payoff. Both of these options would usually provide a greater return to the lender than they would otherwise get through a foreclosure. It is likely that a short refinance would also result in a reduction of the homeowner's credit score due to the write off of debt.
It is also possible that the amount of debt forgiven could be considered taxable income to the homeowner. It is advisable to talk to an accountant or tax attorney to evaluate the possible tax consequences of a short refinance. Typically, forgiven debt causes the inclusion of income under Section 108 of the tax code. There are exceptions, which is why it is prudent to check with a tax adviser.
HUD estimates that between 500,000 and 1,500,000 borrowers will refinance using this program and the net economic benefit will be between $11.774 and $35.322 Billion.
Participation is voluntary and requires the consent of lien holders. In order to be eligible, the following conditions must be met:
- The homeowner must be in a negative equity position;
- The homeowner must be current on the existing mortgage to be refinanced;
- The homeowner must occupy the subject property (1-4 units) as their primary residence;
- The homeowner must qualify for the new loan under standard FHA underwriting requirements and possess a "FICO based" decision credit score greater than or equal to 500;
- The existing loan to be refinanced must not be a FHA-insured loan;
- The existing first lien holder must write off at least 10 percent of the unpaid principal balance;
- The refinanced FHA-insured first mortgage must have a loan-to-value ratio of no more than 97.75 percent;
- Non-extinguished existing subordinate mortgages must be re-subordinated and the new loan may not have a combined loan-to-value ratio greater than 115 percent;
- For loans that receive a "refer" risk classification from TOTAL Mortgage Scorecard (TOTAL) and/or are manually underwritten, the homeowner’s total monthly mortgage payment, including the first and any subordinate mortgage(s), cannot be greater than 31 percent of gross monthly income and total debt, including all recurring debts, cannot be greater than 50 percent of gross monthly income;
- FHA mortgagees are not permitted to use premium pricing to pay off existing debt obligations to qualify the borrower for the new loan;
- FHA mortgagees are not permitted to make mortgage payments on behalf of the borrowers or otherwise bring the existing loan current to make it eligible for FHA insurance; and.
- The existing loan to be refinanced may not have been brought current by the existing first lien holder, except through an acceptable permanent loan modification as described below
To facilitate this program, the U.S. Department of Treasury will provide incentives to existing second lien holders who agree to full or partial extinguishment of the liens.
The Short Refinance Program will be available as an option for loans closed after September 7, 2010 and before December 21, 2012. However, the program relies on loss coverage to be provided from funds under the Emergency Economic Stabilization Act of 2008 and if the availability of such coverage is delayed beyond September 7, 2010, implementation of this program may also be delayed.
This is an interesting program and a good idea in our current real estate market. Anyone who is underwater on their mortgage, but still current on their payments, may want to investigate the possibility of a short refinance if it looks like keeping current in the future will be a problem. The adverse credit and tax consequences may be well worth it for some homeowners.
For more on the program, see FHA's Mortgagee Letter 2010-23.