FHA Refinance Loan Program for Underwater Homeowners

In May 2010, the Department of Housing and Urban Development (HUD) announced changes to the FHA home loan program that would make refinancing possible for underwater homeowners. This new refinance options should be available sometime in fall 2010.

Refinancing Options for Underwater Homeowners

The new FHA refinancing option allows lenders to provide refinancing options for homeowners who owe more than their homes are worth. This is the textbook definition of being upside down or underwater -- owing more on your mortgage than your home is currently worth. This is a widespread problem resulting from the housing and mortgage collapse of 2008. In the past, homeowners who were underwater had few options for refinancing. So the FHA refinance loans should come as welcome relief to many. 

FHA Refinance Procedures and Key Points

The government doesn't always explain their programs clearly. So we have attempted to simplify the FHA refinancing option for underwater homeowners into the following:

  • This is a voluntary financing program that encourages lenders and homeowners to work together, when possible, to restructure or refinance underwater mortgage loans.
  • Not everyone will be able to refinance, regardless of whether or not they meet the criteria listed below. It's a voluntary program for lenders. There are incentives for lenders to participate -- but no mandates. Some underwater homeowners who meet these criteria will be able to refinance into an FHA loan, while others will not.
  • This option allows underwater homeowners to refinance into FHA loans that are no more than 97.75% of the home's current value. After refinancing, the homeowner would owe less than the value of the home. In other words, they would no longer be underwater if they only had one mortgage.
  • In cases where the homeowner is using a first and second mortgage, the maximum loan-to-value (LTV) may not exceed 115% after refinancing.
  • To accomplish the above-stated goal, the mortgage lender would write down (reduce) the principal balance of the first mortgage loan by at least 10%. In some cases, the principal could be written down by much more than 10% -- it's ultimately the lender's call.
  • By reducing the principal balance and refinancing into a low rate, the homeowner will have a lower monthly payment as well.
  • A 31/50 rule is in effect. The homeowner's monthly mortgage payment (after refinancing) must not exceed 31% of income. The total debt load after refinancing must not exceed 50% of the borrower's income. Exceptions to this rule may be granted for borrowers with "especially strong credit histories."
  • As with the regular FHA loan program, mortgage insurance premiums will be applied. This is an upfront insurance cost that the borrower must pay at closing. This premium could be as much as 2.25% of the loan amount.
  • TARP funds are being used to provide lenders with incentives to participate.

Eligibility Requirements for Homeowners

In order to be eligible for FHA underwater refinancing, homeowners must be current on their existing mortgage. They cannot be behind on payments. This is a key aspect of the program, because it's designed to reward responsible homeowners.

You must occupy the home as your primary residence -- investment properties are not eligible. You must be able to document your income. You will need a FICO credit score of 500 or higher. This refinancing option is open to homeowners with mortgages that are not currently insured by the FHA. Standard FHA underwriting guidelines apply to the underwater refinance option as well.

Summary of eligibility requirements:

  1. You must be current on your mortgage.
  2. The house must be your primary residence.
  3. You need to document your income.
  4. You need a credit score of 500 or above.
  5. Available to homeowners who currently have non-FHA mortgage loans.
  6. Standard FHA underwriting guidelines apply.

Additional requirements may be announced when this FHA refinancing option becomes available. We will update this fact sheet with any new developments.

How to Apply for an FHA Refinance

We do not have any details about the application process at this time. More information should be released in fall of 2010, when this refinancing option will be available. As with regular FHA loans, borrowers will probably need to apply through an FHA-approved lender.

The Impact on Your Credit Score

The FHA underwater refinancing option will likely have a negative impact on the borrower's credit score. The reason is that, unlike a regular refinance loan, the FHA program includes a write down of the principal loan amount. Thus, it's a form of loan forgiveness. Whenever a lender "forgives" a debt owed by a borrower, it usually shows up as a negative entry on the borrower's credit report. This would lower the borrower's FICO credit score.

Information released by HUD states that the "short refinancing should be reflected on the borrower's credit score."

We will post more information about underwater refinancing through the FHA as it becomes available. We are expecting a mortgagee letter with additional details and specifics.

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