refinance

Underwater mortgage refinance tough to find

Highlights
  • Mortgage rates near record lows, but underwater borrowers can't refi.
  • Options available if loans owned by Freddie, Fannie.
  • Loan modification is another option for those who can't refi.

The summer has seen the lowest mortgage rates in generations. But there's a problem for homeowners who want to grab those great rates through a refinance.

Roughly one-quarter of homeowners with a mortgage are underwater, owing more than their homes are worth, according to real estate analytics company CoreLogic.

Many such borrowers have adjustable-rate mortgages and want to refi before their mortgage rates adjust higher. But being underwater makes it difficult -- and in some cases, impossible -- to refinance.

Mortgage toolbox
For now, the news is surprisingly upbeat for many of these borrowers: When their loans reset, the mortgage payments are likely to go down, thanks to today's sinking mortgage rates.

"We tell them, hold on; don't be upset about it being an ARM," says Brian Koss, executive vice president of Mortgage Network, in Danvers, Mass. "Most people have been quite happy."

Prime borrowers who documented their incomes typically experience the first rate adjustment three to five years into a mortgage. Such 3/1 and 5/1 ARMs are resetting in large numbers -- about $10 billion worth of mortgages per month, according to industry estimates.

Chik Quintans, mortgage planner for Atlas Mortgage, in Lynnwood, Wash., has seen a fair share of such borrowers whose rate adjustments unexpectedly have resulted in falling mortgage payments.

"There's an automatic assumption that it's going to go up -- it's not going to go down," Quintans says. "So when it does, it's definitely a pleasant surprise."

Quintans says he has a customer whose ARM rate is about to drop from 5.875 percent to 3.25 percent.

"It's basically almost going to cut the mortgage in half, so that's the silver lining for her," he says.

Of course, there's no guarantee the index rate will remain low, and many ARM borrowers prefer to refinance to fixed-rate loans and stop worrying.

So what can underwater homeowners do if they are desperate to refinance?

Refi options

Some borrowers have hybrid ARMs owned by Fannie Mae and Freddie Mac. These borrowers can try to take advantage of the Home Affordable Refinance Program, or HARP, which allows homeowners to refinance their Fannie/Freddie-owned mortgages -- even if they're underwater.

The first step is to discover whether your loan is owned by Fannie or Freddie. You can find a loan lookup tool at the government's Making Home Affordable website.

The FHA and VA have something that's even more borrower-friendly: streamline refinance programs that don't require an appraisal.

The FHA streamline program doesn't allow borrowers to roll the closing costs into the loan, "so you're going to have to come to closing with cash in most cases," Quintans says. "That's difficult for many people."

Alas, other borrowers are less likely to find refi success.

Some borrowers face sharply higher payments when their ARMs reset or recast. That's the case with Alt-A ARMs -- for borrowers who didn't document their incomes -- and option ARMs -- for borrowers who wanted to be able to pay less than the interest incurred during the month.

HARP and streamline refis aren't available on these exotic loans, leaving underwater borrowers with few options.

These borrowers should get an estimate of how much their monthly payments will go up, says Greg Hebner, president of MOS Group, which provides loss mitigation services to mortgage servicers. If the payments become unaffordable, Hebner recommends seeking a loan modification.

Don't wait

You don't have to fall behind on the mortgage payments before asking for a modification.

"If you actually are current when you go into a modification and you actually stay current in a modification, the impact on your credit will be much less than if you fall behind," Hebner says.

He adds that timing is important: Don't modify an option ARM until after it recasts with a higher payment. At that point, the borrower is more likely to qualify for a modification.

Hebner offers some advice for anyone with an ARM, whether it's an exotic option ARM or a stolid 5/1 hybrid.

"Understand the nature of your terms of the mortgage," he says. "What does the reset mean, when is it going to happen, what is the rate going to be and what is my new payment going to be?"

To get the answers to those questions, pull out the loan paperwork and call the servicer.

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