Are any lenders reducing principal balances on underwater mortgages?

By Gina Pogol
Mortgage Credit Problems Columnist

Dear Gina, I've suffered some financial setbacks and my home is underwater. It would really help if I could refinance to a better mortgage rate but I owe more than my home is worth and now I have bad credit too. Is there any help for me? - Skip, Phoenix, Ariz.

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Dear Skip,

The Principal Reduction Alternative, or PRA, is part of the federal government's Home Affordable Modification Program (HAMP). PRA provides compensation to mortgage lenders that write off part of your principal balance to make your mortgage more affordable. So far, over 10,000 of these reductions have been granted and they average about 30 percent of loan balances -- about $70,000!

Eligibility for a Principal Reduction Alternative

If you're eligible for HAMP consideration, you can apply for PRA. Keep in mind this program is voluntary, so your lender gets to decide if it wants to participate and if you qualify. Here are the guidelines:

  • Your mortgage is not owned or guaranteed by FHA/VA, Fannie Mae or Freddie Mac.
  • You owe more than your home is worth.
  • The home is your primary residence.
  • You got your mortgage on or before January 1, 2009.
  • Your home loan's payment exceeds 31 percent of your gross (pre-tax) monthly income.
  • Your mortgage balance is $729,750 or less.
  • You have a financial hardship putting you in danger of defaulting on your mortgage.
  • You have enough verifiable income to support the modified payment.

Lender participation in PRA

Most subprime or bad credit home mortgages are not owned or insured by the government, which might be a good thing for you. There are over 100 lenders large and small participating in PRA. The larger ones include Bank of America, CitiMortgage, JPMorgan Chase, and Wells Fargo.

Equity sharing requirements

Your lender, if it writes off some of your mortgage balance, is allowed to require an equity sharing arrangement. What's an equity sharing arrangement, you ask? It simply involves splitting a post-PRA increase in value between you and your lender when you sell or refinance the home. You are allowed to recover what you have spent on property improvements, and your lender must under the program give you at least 50 percent of the increase in equity.

Tax consequences of a PRA modification

If you are the recipient of a PRA modification, the amount of principal reduction will be taxed as income (because it is). That's something to consider when evaluating your options. In some cases it's better to stay in the home as long you can without paying the mortgage, then letting the house go and avoiding income tax consequenses. Check with an attorney or tax pro before committing to anything.

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