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Options for Distressed Homeowners With Negative Equity

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Today’s homeowners are benefiting from the red-hot housing market, which is sending property values through the roof. On average, homeowners across the country scored a $26,000 bump in home equity in 2020, according to CoreLogic.

Depending on where you lived, those gains were substantially higher—California, Idaho and Washington averaged $50,000 in home equity increases annually. Meanwhile, states like North Dakota, Iowa and Oklahoma saw considerably lower equity lifts with an average of $9,000 year-over-year.

For homeowners who can no longer afford their mortgage payments, the amount of equity in their home can mean the difference between selling for a profit and facing foreclosure. Generally, homeowners need 10% or more equity in their home to cover closing costs, plus any overdue mortgage payments.

If your mortgage is more than your house is worth then you have negative equity. This is also known as being upside-down or underwater with your mortgage. Although this is not the ideal position to be in, there are options.

1. Apply for Forbearance

For homeowners who are facing financial hardship due to Covid, there’s still time to apply for forbearance, which allows you to pause mortgage payments for up to 18 months. For homes backed by Fannie Mae or Freddie Mac, the deadline to apply for forbearance is June 30. There’s also a foreclosure moratorium on federally backed homes set to expire on June 30.

About 70% of homeowners are eligible for forbearance. For borrowers who don’t have loans backed by Fannie or Freddie, there’s still a chance your lender will offer a forbearance plan or some other type of assistance.

Borrowers who want to enter into a forbearance agreement must contact their lenders—this is not an automatic program. Documentation of your financial hardship often isn’t required, you simply must attest that you were affected by Covid.

2. Refinance Your Mortgage

Refinancing a mortgage with negative equity is nearly impossible, but there are two federally backed programs that give underwater homeowners a chance to refinance.

The Fannie Mae High LTV (loan-to-value) Refinance Option and Freddie Mac Enhanced Relief Refinance are both programs designed to help homeowners who are current on their mortgage payments but have an LTV ratio that is higher than what standard refinances allow.

The benefits of refinancing through these programs are that you can lower your monthly payments, reduce your interest or switch from an adjustable-rate mortgage to a fixed rate.

3. Apply for a Loan Modification

Homeowners who have suffered a job loss or income reduction, or are nearing the end of a forbearance period (and still can’t afford their regular mortgage payments), might be eligible for a loan modification through their lender.

A loan modification is basically when your lender changes the terms of your mortgage to make it more affordable for you. These loan modifications are usually permanent and can include a variety of changes such as extending the length of your loan (which can lower your monthly payments); reducing the principal amount or interest rate. Sometimes lenders will combine a few changes.

Unlike a refinance, which can come with hefty fees, modifications are free because eligible borrowers typically can’t afford costly refinance fees. But sometimes the process can be lengthy so be sure to talk to your lender at the outset of financial struggles.

Consider a Short Sale

A short sale is a last-ditch option if you can’t refinance or sell for a profit and you’re facing foreclosure. Basically, a short sale is when a lender agrees to sell your property and write off the losses if it sells for less than the mortgage balance.

Some lenders might be tempted to agree to a short sale if they don’t want to deal with the headaches, time and money of going through a foreclosure. The advantage of a short sale over foreclosure is that you’ll keep your credit profile intact.

However, homeowners should consider where they might live after a short sale as today’s housing market is not on the buyer’s side.

“Evaluate the market and where you plan to live after your home gets sold,” says Julie Aragon, a mortgage broker at Julie Aragon Lending Team in Los Angeles. “In most regions of the country real estate is in short supply and very high demand, so it’s not a good time to be a buyer. Make sure you’re planning a few steps ahead if thinking of selling your primary residence.”

Bottom Line

The most important thing you should do if you’re struggling to make a mortgage payment is to contact your lender immediately. Often, homeowners in financial distress are already worried and anxious, so they put off dealing with lenders in order to avoid additional stress.

However, this is the worst move you can make. Instead, know what your options are (see above) and work with your lender to come up with a solution that is financially manageable, and keeps you in your home.


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