Picture the following scenario: You purchased your three-bedroom dream home six years ago. Located on a picturesque oversized lot in a highly desirable new subdivision, your home has Brazilian Cherry hardwood floors, matching cherry cabinets in the kitchen and granite countertops. You have huge walk-in closets in the master bedroom, which has a balcony that overlooks the expansive backyard where the kids have plenty of space to romp and play. The schools are excellent.
The price may have been a bit steep, but you had faith in the American economy and knew historically ? real estate values appreciate over the long run.
The New Economics: Underwater Mortgages
These days, the news contain story after story of homeowners “underwater” with their mortgage. This simply means due to falling real estate prices, many people owe mortgage amounts that exceed the value of their homes. Communities in Nevada, California and Florida have suffered the hardest hit. At the end of the first quarter of 2010, Modesto, California homeowners experienced home values down an average of 35 percent below the mortgage owed on their home (Where Americans Are Losing Home Equity Most).
According to real estate data supplier CoreLogic, 23 percent of American homeowners have mortgages underwater at the second quarter ending June 30, 2010. This equates to 11 million homes. The figure actually dropped from the 11.2 an increase in foreclosures. In addition, data shows that 2.4 percent of the homeowners with mortgages had less than 5 percent equity in their homes.
With so many homes saddle with underwater mortgages, the probability of a default increases. Borrowers who are underwater with their mortgage now have three options:
1. Continue making their mortgage payment and trust that real estate values reverse their downward trend
2. Speak to their lender about the new Principal Reduction Alternative (PRA)
3. Employ a growing tactic called “strategic default” and “walk” away from their mortgage
Options 2 and 3 represent the most viable alternatives for many homeowners.
Principal Reduction Alternative
Back in March 2010, the Federal Housing Administration (FHA) announced plan designed to provide some financial relief for homeowners with “underwater “mortgages. The Principal Reduction Alternative program became active in mid-September. The Obama administration expects PRA to provide financial relief for about 500,000 to 1.5 million households. Lenders may refinance loans for borrowers who owe at least 15 percent more than the current value on their home. To qualify for the plan, homeowners must be current in their mortgages.
Borrowers participating in mortgage modifications through other programs, such as the Home Affordable Modification Program (HAMP) or alternative plans offered by financial institutions may partake of the new program. Investors can actually look through their portfolio of holdings and choose which borrowers will get to refinance their mortgage, which the FHA will guarantee. However, lenders must forgive a minimum of 10 percent of the original mortgage.
Is PRA Really the Answer?
Many market analysts believe the plan has overly ambitious estimates for the number of homeowners expected to benefit. Barclay Capital projects PRA will help approximately 200,000 to 300,000 homeowners. Most critics of the Principal Reduction Alternative point out the dismal performance of the Obama administration’s flagship program HAMP, which had a dropout rate of 48 percent in July 2010.
This means that of the 1.3 million households signed on to HAMP since March 2009, 630,000 dropped out of the program. In August 2010, the number of people cut from the program increased to 663,000 or 51 percent. The Treasury Department originally anticipated that 3 to 4 million homeowners could receive help from HAMP by the year 2012.
The reasons why the program has not helped as many households as expected depends on whom you speak to concerning the abysmal results. Numerous borrowers have said they forwarded the required paperwork to lenders only to have the banks claim they never received the documents. Many lenders complained the Obama people coerced them to sign up households without receiving proof of income. Later, banks would gather the necessary data only to find financially trouble people who did not qualify or dropped out of the program.
Meanwhile, officials from the White House defends HAMP, stating that lenders make sizable reduction in borrowers’ mortgage payments. In addition, major banks offer HAMP dropouts alternative mortgage reduction programs.
Several industry experts believe the time has ended for “discretionary participation” by lenders, and the time has come for clear objectives and benchmarks established by the Treasury Department to ensure borrowers receive effective assistance. HAMP watchdog Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program, has echoed the same concerns.
Strategic Default: A Moral Dilemma for Borrowers
Strategic default refers to any homeowner, who has the financial wherewithal to make their mortgage payments, but decides to cease paying and “walk away” from a mortgage substantially underwater. Before the current economic climate, strategic defaults were virtually nonexistent. Research has showed strategic defaults make up approximately 20 percent of total defaults. Loss of income and underwater mortgages make up the remaining 80 percent.
For many borrowers, defaulting on their mortgage constitutes a moral quandary. Wall Street Journal.com reports that Fannie Mae conducted a survey that revealed 88 percent of Americans feel the practice is unacceptable. Besides the issue of morality, borrowers may sustain as much as a 20 percent drop in their credit score and the inability to qualify for a mortgage for 36 months. A Federal Reserve Board study determined that “median borrowers” who walk away from their home did so after the home value dropped more than 62 percent below the mortgage owed.
What You Can Do To Save Your Home
Only the borrower determines the best course of action for his or her family. For many homeowners, it becomes an issue of economic survival. Many neighborhoods have loss their appeal because of the increasing amounts of foreclosures. Even with an economic recovery, most people have concerns about the resiliency of home values.
If you owe more than the value of your home, contact your lender to find out if you qualify for the Principal Reduction Alternative. Be sure to ask about other loan modification alternatives. If you cannot resolve your situation with the lender, contact a HUD-approved housing counseling agency. These organizations offer free assistance and can work with you to save your home from foreclosure.