Despite recent glimmers of hope that the economy is improving, the news on the housing front remains bad, and getting worse for many homeowners. In May, the Mortgage Bankers Association reported that a record 12 percent of home-owners were behind on their payments or in foreclosure. Of the new foreclosures, 29 percent were on fixed-rate loans to borrowers with good credit.
Worse yet, the foreclosure rate on prime fixed-rate loans has doubled in the last year. What has changed is that many prime borrowers who had stable incomes and manageable mortgages are increasingly in financial straits, often after they or their spouse lose a job, or their bonuses, wages, or benefits are trimmed.
Many people in this situation immediately dip into their liquid cash (maybe savings or checking accounts) or even their stock portfolio or retirement accounts to cover the unexpected shortfall in paying their mortgages. But some financial experts say that's a poor strategy that can leave you with little in reserve for new emergencies, such as a medical crisis.
If you or someone you know is in this difficult situation, don't despair. There are options that might allow you to lower your mortgage payments and keep your other assets intact: loan modification or mortgage refinancing, part of the Obama administration's housing plan. (You can find full details at makinghomeaffordable.gov.) Here's how they work.
This might be an option for you if your monthly housing outlay (including mortgage payment, real-estate taxes, homeowners insurance, condo fees, and the like) exceeds 31 percent of your monthly income before payroll deductions. A lender will take steps to reset your payments to the 31 percent threshold. First, it can reduce your interest rate to as low as 2 percent. It can also extend the loan's term to up to 40 years or defer payment of the principal.
The new payment level will be in place for a three-month trial period. If you pay on time, it will be extended for five years, then the rate will be adjusted upward by no more than 1 percentage point a year until it reaches the prevailing market rate set at the time the modification was made. Your mortgage must have originated on or before Jan. 1, 2009, and the unpaid principal must be equal to or less than $729,750.
To qualify, you need to have a steady income, so if your financial woes are the result of a job loss rather than a drop in income, you should try to find another job right away. Also, your mortgage must be owned or securitized by Fannie Mae or Freddie Mac. (You can find out if these agencies hold your loan at www.fanniemae.com/loanlookup and www.freddiemac.com/mymortgage).
If you have a good payment history—you haven't been more than 30 days late in the past 12 months or, if you've had the loan for less than 12 months, you've never missed a payment—the lender will restructure your loan into a 15- or 30-year mortgage at market rates. Fannie Mae borrowers may finance all normal closing costs, such as fees for an appraisal or title report, and take out $250 in cash. Borrowers whose loans are owned or securitized by Freddie Mac can finance normal closing costs not to exceed 4 percent of the unpaid principal balance or $5,000, whichever is greater, and take out $250 in cash.
Even homeowners who are underwater—that is, they owe more than the home is worth—are eligible to refinance. The government recently expanded these guidelines, allowing refinancing of up to 125 percent of the property's current market value (up from 105 percent).
To get started with either program, call your lender. Be aware that this process, although improving, can take months to complete. So be prepared to contact your lender frequently and to provide plenty of documentation to support your request.
If you don't qualify for these mortgage adjustments—for example, if you've lost your job and have no income—there are options to consider that may allow you to keep paying your mortgage (or sell the house without penalty) and avoid foreclosure. For starters, tell your lender what the problem is and request forbearance. Explain that you are committed to paying your mortgage but you need six months or even a year to find another job and get back on your feet. Many lenders will agree to lower your rate or let you pay only the interest for as long as 18 months, without reporting a delinquency to the credit bureaus.
If you have a home equity line of credit, you might be able to use it to cover your mortgage for a short time rather than dipping into savings or a battered stock portfolio. But this is only a stopgap measure, since the money you take out through the credit line is added to your outstanding mortgage debt, which could affect your ability to refinance later on.
If you're forced to turn to your assets, remember that you may incur tax liabilities by selling stocks or cashing out your retirement plan. You might not want to lock in losses by selling stocks or mutual funds that have dropped in value. If you're over age 59½ you can take distributions without penalty from an IRA, but you will owe regular income tax on the withdrawals, and you might run out of the money to finance your later years.
"Instead, you can take advantage of low interest rates by borrowing against your 401(k), if you're still working, or your cash-value life insurance policies," says Joe Spada, a financial planner and managing director at Summit Financial Resources in Parsippany, N.J. "Also, most annuities allow you to withdraw 10 percent of your principal." In such cases, there are no penalties for tapping into the money before retirement. But if you borrow from your 401(k) and fail to pay it back, you'll have to pay taxes on the amount you withdrew.
If none of these steps are feasible, see if your lender will agree to a short sale. This means you sell your home for less than the outstanding mortgage, which the bank will accept as payoff on your loan. The downside is that it might have a negative impact on your credit score.
Attorneys usually charge about $2,000 to handle loan modifications, and many promise to refund part of the fee if they don't succeed. Another option can be found at emodifymyloan.com, a Web site that will help you create a document package that you can use when dealing with your lender. Cost is less than $100.
But before you hire a specialist, talk to a government-certified housing counselor. At low or even no cost, a counselor can help you organize your finances and prepare documents for your lender. You can find one by going to the Web sites of the U.S. Department of Housing and Urban Development or NeighborWorks America.
Most important, don't fall for a scam. Some "foreclosure rescue" companies ask you to sign over the deed to your home while they work on resolving your problems. Others ask you to pay the mortgage directly to them as they work out the new loan. Still others take your money and do nothing.
To avoid foreclosure scams: