Asset Allocation Strategy

Homeowners facing payment difficulties should consider two options-loan modification versus refinance-when seeking a solution to an unaffordable home loan. What is the difference between the two and what are the pros and cons of each option? Here is a brief description of what each option has to offer a struggling homeowner:

There are several factors preventing people from taking advantage of the lowest mortgage rates we have seen in a long time. The most prevalent reason is that the mortgage is underwater. The decreases in home values have left many people with little or no equity in their homes. Typically, if you do not have any equity in your home, you cannot refinance your mortgage. Additionally, qualifications for refinancing have become much stricter. The days of obtaining a “no documentation/no verification” loan are long gone. Lenders have also raised the bar on credit requirements. As more and more people struggle to survive in the current economy, credit ratings are falling. This increases the difficulty of qualifying for a refinance, even for people who are current with their mortgage payments.

There are, however, some limited options for underwater homeowners. The Federal Housing Authority (FHA) and The home affordable refinance program (HARP) may offer opportunities to refinance. In order to qualify for these options, homeowners must be current on their mortgages. People who are delinquent with their payments need to try one of the loan modification programs first. The FHA and HARP programs are designed to help lower monthly mortgage payments. The biggest drawback to these programs is that the bank who holds the current loan must agree to write off a percentage of the mortgage principal. Many banks have been unwilling to do this, frustrating homeowners that are continuing to make payments on a home with negative equity.

How Does the Home Affordable Modification Program Work? The mortgage lender will first have to reduce monthly mortgage payments so that the homeowner’s housing expense is no greater than 38% of their gross income. Next, the program will match further reductions in monthly payments dollar-for-dollar, from 38% down to 31% debt-to-income ratio for the borrower. To reach the target affordability level of 31%, interest payments will first be reduced down to as low as 2%. If at that rate the debt to income level is still over 31%, lenders then extend the term or amortization period up to 40 years, and finally forbear principal at no interest (i.e., lower the mortgage balance) until the payment is reduced to the 31% target. To ensure long-term affordability, the modified payments will be kept in place for five years and the loan rate will be capped for the life of the loan. After five years, the interest rate can be gradually stepped-up by 1% per year to the conforming loan survey rate in place at the time of the modification. Homeowners with a high debt-to-income ratio (a ratio measuring all debt such as housing expenses, car loans, credit cards, etc…) will be required to enter a certified consumer debt counseling program. They will, however, still be eligible for the modification program.

All of this information is reviewed and a determination is made if the borrower is eligible. Since the approval guidelines and modification terms are standard for everyone, homeowners can increase their chance of success by taking the time to learn how to properly prepare their application before contacting their lender. Struggling homeowners should take the time to research all of their options to determine which program they can qualify for and which option will be the most beneficial. A loan modification can be the answer to a lower monthly loan payment by lowering your interest rate, lengthening the term or other features designed to help you avert foreclosure. Take the time to research, learn and prepare before you make any decisions affecting your home and family.

Learn more about Obama Mortgage Relief Plan Qualifications.