The Dilemma of “Underwater” Mortgages

The real estate crisis and recession have impacted nearly everyone – and in many different ways. The unemployment rate is close to 10 percent in Georgia. Numerous homeowners have lost their homes to foreclosure. Many small business owners have closed their doors.

And as if all of these problems were not enough trouble, there is another byproduct of the devalued real estate market that is increasingly causing a lot of stress for homeowners – “the underwater mortgage.”

As a specialist in real estate law at the Gainesville, Ga.-based law firm Stewart, Melvin & Frost, Scotty Ball certainly has a unique insight and perspective on what has taken place on the front lines of the real estate market crisis.

Question: What is an “underwater mortgage”?

Scotty: An “underwater mortgage” is an unfortunate financial dilemma that occurs when your mortgage balance exceeds the value of your home. Another name or industry label for this type of situation is an “upside-down mortgage”.

In my real estate practice with Stewart, Melvin & Frost, I am seeing a noticeable increase in these underwater mortgages, particularly in the last several months.

It’s ironic that we are witnessing an increase in these stressed mortgages – just as we see signs of a slow but steady recovery in housing. I believe the reason is that home values are finally responding to the large number of foreclosures that have moved through this real estate market. It’s difficult for your home to maintain its value when your next-door neighbor’s home is foreclosed and sells for less than half its original value.

Also, I believe another reason that we’re seeing more of these underwater mortgages is that a lot of short-term notes (three-year, four-year, etc.) that were established prior to the recession are just now coming due. In many instances, these borrowers used their homes as collateral to secure these notes.

Question: So your home mortgage is “underwater” or “upside down.” How does that affect the typical homeowner?

Scotty: If you’re keeping up with your mortgage payments and you don’t plan to move any time soon, then it really doesn’t affect you – unless you can’t sleep at night for the same reason that you’re worried about the drop in your 401-K and your future retirement plans.

However, the dilemma that I have seen happen quite a bit is when someone has used their home as security for another loan, perhaps for an investment property. When the note comes up for renewal, the bank often requires the investor to put up more money to offset the loss of value in the home that was used as security for the loan.

On the residential side, the “underwater mortgage” has created a “Catch-22” for people trying to take advantage of the low interest-rate environment. I have seen many homeowners attempt to refinance their homes, only to discover that they have lost too much equity in their home due to the devalued real estate market. So their application is turned down by the bank. This can be especially disheartening if you’ve lost your job and you’re having a hard time keeping up with your mortgage payments.

The new “gold standard” for home equity – whether for a home equity loan or a new home purchase – is now at 20 percent. If you don’t have at least 20 percent equity, you will find it difficult to use your home as loan collateral. And if you can’t buy a new home with a 20 percent down payment, then it will be difficult to work out a favorable interest rate and other beneficial loan terms – or you may even be turned down for the home loan.

Question: So what’s a homeowner to do if your mortgage is “underwater” and you’re having difficulty making your monthly payments? Is refinancing no longer an option?

Scotty: Not necessarily. First, I would suggest that you talk to your banker. Be aware that while banks may seem to be the bad guy here, they are actually responding to much stricter loan requirements by federal regulators.

The following are some possible options that may be able to assist you:

HARP. Your underwater loan may be eligible for a refinance through the federal Home Affordable Refinance Program, or HARP. This program allows qualified borrowers to refinance a loan that is from 105 percent to as high as 125 percent of a home’s value. Not every underwater loan qualifies. For example, any delinquent payments in the past 12 months will automatically disqualify you. But if you are lucky enough to qualify, it could be the difference in keeping your home and getting your mortgage right side up again.

Second Option: HAMP. If you have an underwater mortgage and have also missed payments, there is another option through the federal government called the Home Affordable Modification Program, or HAMP. To qualify, you must demonstrate financial hardship that has put your mortgage at risk. HAMP is not a refinancing program – but it can temporarily modify – or lower – your payments for up to 60 months. Again, check with your financial lender to determine whether you might qualify.

Third Option: If you don’t qualify for federal assistance and you know you’re in trouble with your mortgage, don’t hide under a rock and hope that the problem will go away. Try to negotiate a loan modification with your mortgage lender. They would much rather work with you to keep the loan intact and avoid a foreclosure if at all possible.

Fourth option: If all else fails and a foreclosure seems imminent, ask your lender or realtor about a short sale – which means selling your house at market value, with the remaining loan balance written off by the lender. A short sale is not a positive thing for the seller or for the lender, but it is certainly preferable to a foreclosure.

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