Paying Down Mortgage When Underwater

Paying down mortgage balance may be beneficial for many homeowners, but if your loan is underwater, is it still worthwhile?

Q: I cannot find a straight answer to this anywhere. Is it worth paying extra on the principal on our loan if my home is underwater? We plan on being in the home for at least five more years or until we can sell easily.

Right now it seems like throwing good money after bad if it’ll still take years to gain equity. Would I be better off investing or saving that money now?

Separately, are there any underground rumblings or things on the horizon for homeowners that are underwater and don’t qualify for HARP (Home Affordable Refinance Program) or HAMP (Home Affordable Mortgage Program)? I, like thousands of others, don’t meet the extremely rigid guidelines because I pay private mortgage insurance (PMI). I had heard there might be help coming. Is that true?

A: You raise a good question on whether you should pay down the principal on your loan if your loan is underwater.

The short answer to that question would depend on what your financial situation is and what your financial situation will be in the future.

If your financial situation is strong and if you had to sell your home this year or next and were short funds to pay your lender, would you have the financial means to pay the lender the deficiency from the sale and preserve your high credit score and great credit history. If you were to answer that you would pay off the lender in full, then paying down your loan would be a hedge against having to come up with that money in the future all at once.

If the answer is that you don’t have the cash to pay off the lender now and probably won’t for years to come to make the lender whole on the sale of the home and need the lender’s permission to go through a short sale, you’re probably right in thinking that you are throwing good money after bad. If that’s the case, you might need the money for home repairs, to pay for your living expenses now and put money aside for your children’s education or for your retirement. These are all financial decisions only you can make.

If the real estate market in your area recovers to a point where you can sell your home and not have a balance owing to the bank, you’ll have done very well. Keep in mind that if you are of the mindset that doing a short sale and having the lender release you from any balance you might still owe on the loan is morally wrong, you can sign a promissory note and agree to repay any deficiency to the bank on an installment basis after the sale of the home.

On your second question, recently the federal government announced a new plan to allow homeowners to refinance their home loans under what is being called HARP 2.0, the new and improved version of the Home Assistance Refinance Program. But the old program helped only a fraction of those homeowners that needed assistance. The new program started December 1, 2011, so we will wait and see what this new plan actually does.

Our hopes aren’t too high. The new plan is supposed to encourage mortgage servicers and the mortgage loan investors to refinance borrowers under certain circumstances. The main purpose of this new plan is to allow people that would otherwise qualify to refinance but can’t because their home has worth less than the loan amount (called negative equity).

The other item that is of interest is that the original bank that gave out the loan to a homeowner may be on the hook for misrepresentations and other bad loan practices that could come up with that loan, so the new plan attempts to minimize or change the responsibility held by the original lender.

However, the rules can get technical and some lenders may decide that it might not be in their best interest to refinance the loan. The government plans don’t require lenders to refinance loans. It is entirely voluntary. But the government hopes that by reshaping the incentives and changing the penalties, lenders will refinance more loans.

The underlying flaw is that most of these loans have an interest rate that is far above where mortgage interest rates are today. Wouldn’t you think that an investor holding on to an investment that pays five, six, seven percent or more interest today would rather keep that investment, rather than allow it to go away and then have to reinvest those monies in other investments that will pay far less?

If that’s the case, HARP 2.0 will continue to be merely window dressing without achieving great results. If a lender believes that its original loans were properly reviewed, with the proper paperwork, with proper appraisals and is comfortable with its original loan review process, that lender might not allow the refinancing under the new plan. But if a lender suspects problems with its original loan paperwork and the new plan gives the bank a way out, that bank will end up allowing the refinancing if the bank feels that it can be absolved of its original loan issues.

Obviously, one last issue that needs to get hammered out is how to deal with the PMI companies. It’s unclear at the moment how this issue will get worked out. But wait until mid-December, once more lenders are up and running with HARP 2.0, to contact your lender and begin the conversation.


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One Response to Paying Down Mortgage When Underwater

  1. AP says:

    I have been investigating the HARP 2.0. Thanks for giving your opinion on it. You sound as skeptical about it as I feel at this point. I am concerned that my mortgage company (Citimortgage) doesn’t even know about this (according to the loan officer I spoke to) and has possibly no intention of opting IN to the deal. I understood the whole idea was to take down a good customer’s interest rate without paying for an appraisal or closing costs. Just TAKE IT DOWN, man! I would probably qualify, but why would they want to help me…a great, long-time, good-paying customer with equity in my home, solid career, great credit rating, yet, a low home value due to all the foreclosures in my neighborhood??? My neighbor’s foreclosed home just sold for 1/2 of my original purchase price. I want to cry. Luckily I am not needing to sell right now. I cannot get refinanced without paying at least $4,000 – which includes a $450 appraisal and $3,500 closing fees. How will that help me go from a 20 yr. loan down to a 10 yr? I have already paid on it for 7 1/2 years…and would like to take my 5.7% down to the 3% or better. I see no hope in my future for THAT to happen. I would probably consider paying MORE each month or 2X per year, but I am currently stashing what little I can in a Roth and focusing on my retirement funds. I currently owe $87,000. I am NOT going to pay $4,000 for a refinance deal when I could put that into a Roth. Yet, I want to have my home paid off by the time I retire…any ideas?

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