When real estate values crashed during the Great Recession, many homeowners found themselves in a difficult situation: they owed more on their mortgages than their homes were worth. This situation prevented borrowers from refinancing. To address the problem, the federal government created the HARP loan. Unfortunately, the program ended in 2018, but alternatives exist. As such, we’ll use this article to provide background on the HARP loan and options currently available to borrowers.
Specifically, we’ll discuss the following:
- Underwater Mortgages and the Trouble with Refinancing
- The HARP Loan
- HARP Loan Alternative #1: Fannie Mae High LTV Refinance Option
- HARP Loan Alternative #2: Freddie Mac Enhanced Relief Refinance Mortgage
- HARP Loan Alternative #3: Short Sale
- Final Thoughts
Underwater Mortgages and the Trouble with Refinancing
If you listened to the news or owned a home during the Great Recession, you likely heard the term “underwater mortgage” frequently. In simple terms, this means that a mortgage balance exceeds the current value of a home. For instance, say you owe $250,000 on your mortgage, but the home has a value of $200,000. In this situation, you’d be underwater on your mortgage, as you owe more than the home is worth. Normally, borrowers become underwater due to a widespread collapse in housing prices – as what happened during the Great Recession.
Being underwater on a mortgage makes refinancing your loan difficult – if not impossible. To provide a mortgage, lenders want to make sure that the associated home will serve as full collateral for the loan. That is, if you default on the mortgage, the bank could seize and resell the home to recoup the outstanding loan balance.
But, if your home is worth less than the current mortgage, refinancing that current loan into a new loan would leave lenders with insufficient collateral. Continuing the above example, most lenders wouldn’t refinance that $250,000 loan into a new $250,000 mortgage knowing that the underlying property is only worth $200,000. For this reason, underwater borrowers struggle to take advantage of lower interest rates, as most lenders won’t approve refinancing in these situations.
The HARP Loan
Millions of homeowners found themselves underwater on their mortgages in the aftermath of the Great Recession. As a result, they could not take advantage of decreasing interest rates by refinancing their homes. To address this problem, the federal government created the HARP loan, or Home Affordable Refinance Program.
Administered by the Federal Housing Finance Agency, the government established HARP in April 2009. The program provided borrowers with loan-to-value (LTV) ratios of greater than 80% a refinance option to take advantage of lower interest rates. For instance, say your home was worth $200,000, an 80% or greater LTV would mean you had a mortgage of $160,000 or greater on that home ($200,000 value x 80% LTV). Traditional lenders normally wouldn’t refinance loans with that high of an LTV, so HARP provided a welcome alternative to these borrowers.
In its original form, HARP set an LTV maximum of 105%. To reach more borrowers, the government then increased this ceiling to 125%. By October 2011, the government completely removed the LTV maximum for the HARP loan, meaning any borrower could qualify, regardless how underwater he or she was on a mortgage.
During the program’s existence, more than 3 million borrowers refinanced their mortgages with HARP loans. Unfortunately, though, the program expired Dec. 31, 2018. Consequently, borrowers who are currently underwater on their mortgages need to look to the following HARP loan alternatives.
HARP Loan Alternative #1: Fannie Mae High LTV Refinance Option
To fill the HARP gap, Fannie Mae created its High LTV Refinance Option. This program is tailored for borrowers who A) make timely mortgage payments, but B) have an LTV high enough to disqualify them from traditional refinance options. In other words, the program serves reliable borrowers who have been hurt by economic forces outside of their control.
To qualify for this program, borrowers need to be current on their mortgage payments with no 30-day delinquencies over the past six months. Related, borrowers can have no more than one 30-day delinquency over the past year and no delinquencies greater than 30 days.
Furthermore, borrowers must receive one of the below benefits from a refinance to qualify for the Fannie Mae program:
- Lower principal and interest payment
- A shorter loan amortization term (e.g. refinance from a 30-year to 15-year loan)
- A lower interest rate
- A refinance from an adjustable-rate to fixed-rate mortgage
HARP Loan Alternative #2: Freddie Mac Enhanced Relief Refinance Mortgage
The next major HARP alternative applies to Freddie Mac borrowers. Similar to the Fannie Mae product, Freddie Mac’s Enhanced Relief Refinance Mortgage is designed for borrowers who A) make timely mortgage payments, but B) have an LTV that disqualifies them from traditional refinance options.
For borrowers using this program to refinance into a fixed rate mortgage, no maximum LTV exists. This provides a tremendous amount of flexibility for underwater borrowers to take advantage of lower interest rates. However, borrowers refinancing into an adjustable-rate mortgage face a 105% maximum LTV.
HARP Loan Alternative #3: Short Sale
This final option is not a refinance option, per se. While both of the above options can help borrowers lower their interest rates, neither reduces the actual loan balance. Rather, with fees, borrowers may end up with an even larger loan balance. As such, neither program addresses the underlying problem of owing more on your home than its current value.
Accordingly, some borrowers view short sales as a better alternative. With a short sale, borrowers must A) have no equity in their homes, and B) be facing financial hardship. If so, they can approach a bank to seek a form of compromise known as a short sale. Essentially, the bank realizes that, due to the home’s decreased value, it cannot recoup its entire loan balance via the foreclosure process. Instead, it agrees with the borrower to accept a lesser amount to satisfy the entire outstanding loan balance.
Short sales are not easy processes, as the bank must sign off on any purchase offer. Additionally, homeowners receive no cash from the sale, as all proceeds go to paying off the loan. But, from a credit report perspective, short sales tend to reflect less poorly than a loan foreclosure or bankruptcy. This approach will still adversely affect your credit report for at least seven years, though, meaning borrowers should seriously weigh alternatives before pursuing a short sale.
Borrowers who are underwater on their mortgages often struggle to find refinance options to take advantage of lower interest rates. And, this problem was exacerbated when the HARP loan expired at the end of 2018. Fortunately, Fannie Mae and Freddie Mac have created HARP loan alternatives, providing qualifying underwater borrowers a refinance option.
Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.
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