Understanding Principal Reduction for an Underwater Mortgage

Written by: Scott Sery

Understanding Principal Reduction for an Underwater Mortgage

Part of the American dream is to be a homeowner.  The pursuit of obtaining that status symbol, and separating oneself from those who have not yet achieved home ownership, caused housing prices to skyrocket.  Every bubble must burst, and with the drop off in housing sales came a slump in housing prices.  Many new homeowners found they owed more on their homes than the house was actually worth, in other words, they were in an underwater mortgage.  Since the start of the housing crisis congress has been working on a way to help those who face an imminent foreclosure with programs like the Principal Reduction Alternative of the Making Home Affordable program.

After buying a house at the top of the bubble, a home owner may find they are underwater with their mortgage.  As long as they are still making payments, they have options as to what they can do to get their mortgage back on track.  The Principal Reduction Alternative will allow the person to work closely with their bank, and have the negative equity wiped out.  That means their mortgage will be reduced to the amount of the appraised value of the house.  This program is not for everybody, however, there are some pretty strict eligibility requirements a person must meet before they can be considered.

The biggest benefit of the PRA program is obviously to the homeowner. The bank has to write off some of the principal on the loan in hopes that the homeowner will stick around and keep making their payments.  This is why even one missing document can cause the homeowner to start completely over in the application process.  Banks do not want to take a hit, but they would rather write off part of the loan, than the whole thing.  The homeowner could simply walk away and allow the house to be foreclosed.  This seems like the easiest option, but it can result in a 200 to 300 point reduction on their FICO score.  With that big of a hit there is little chance they will be able to finance anything in the near future.  While there are a great number of good aspects to the program, many people, such as James R. Hagerty from the Wall Street Journal feel the program could actually end up causing more foreclosures than it will prevent.

Banks are not in the real estate business.  By taking ownership of a property they end up losing money by selling the house quickly and cheaply, and paying all the maintenance and upkeep costs until it can be sold.  So banks will do whatever they can in order to help a homeowner stay in their house.  Through the PRA program, or an FHA short refinance, or one of the many other options available through MakingHomeAffordable.gov people have options.  This program gives those who feel their home is no longer affordable some leverage. With care in filling out the application, and making sure all the proper documents are in order, they can keep their home and not worry quite as much about making those monthly payments.


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