Since the recent housing market crisis, some borrowers have experienced a heavy loss of equity in their home's value. Negative equity occurs when the current mortgage balance exceeds the value of the property. A homeowner in a negative equity position may borrow money against the property by refinancing with a loan insured with the Federal Housing Administration.
A homeowner can borrow against a property by refinancing the home. A refinance transaction pays off a previous home loan with proceeds from a new loan. The refinance loan acquired is typically higher than the previous loan because it covers the closing costs. A cash-out refinance allows a borrower to obtain a portion of the equity in his home, further increasing the loan balance. A borrower cannot cash out on a home with negative equity.
FHA's short refinance allows the borrower to obtain an affordable, stable home loan. Participation in the program requires that the lender write-down, or reduce, the principal balance on the loan to no more than 97.75 percent of the home's market value. FHA is widely used by low- and moderate-income borrowers to finance home's with minimal down payment or refinance with minimal equity. The government mortgage insurance program guarantees the lender reimbursement if a homeowner defaults on an FHA loan. The government's Making Home Affordable initiative created the FHA short refinance program to help stabilize the housing market.
To refinance a loan with negative equity, the homeowner must be current on the home loan payments and occupy the property as a permanent residence. The home must have no more than four units and the current home loan must be a non FHA-insured loan. The borrower must qualify for the loan with an FHA-approved lender according to the administration's underwriting guidelines. The minimum credit score requirement is 580 and borrowers must provide proof of income, assets and employment.
The current primary lender's participation in the FHA short refinance program is on a voluntary basis. To participate, the lender must agree to write off at least 10 percent of the loan's principal balance. When the refinance involves a second mortgage, such as a Home Equity Line of Credit, also referred to as HELOC, the loan must be re-subordinated, or positioned secondary to the new first loan. The combined loans may not exceed 115 percent of the home's value.