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Four things to know about the Principal Reduction Alternative
For many of those looking to refinance their home mortgage, obtaining a principal reduction may be what they have in mind. The principal reduction alternative, however is typically offered as a final solution for borrowers seeking help under the Making Home Affordable act when other measures such as an interest rate reduction or a loan term extension are not enough to lower the monthly payment to the desired amount.
If a principal reduction is what you hope to obtain, here are few things to consider:
1. The principal reduction alternative is available through the Home Affordable Refinance Program or HARP Program, which was created in 2009 to help homeowners on the verge of foreclosure stay in their homes by refinancing their mortgages. To qualify, a borrower must be enduring a financial hardship and have a monthly payment that exceeds 31 percent of their monthly income. Other eligibility requirements also apply.
2. The goal of the program is to reduce the borrower’s monthly payment to 31 percent or less of their monthly income. To accomplish this, the loan servicer will use different alternatives, beginning with interest reduction and loan term extensions. Principal reduction is usually only offered in situations in which the applicant is severely underwater. If the loan-to-value ratio exceeds 115 percent, then the lender must consider a principal reduction as a viable option for achieving a lower monthly payment for the borrower.
3. When a borrower successfully obtains a principal reduction, the current unpaid principal is divided into two separate amounts. One amount is the new interest bearing principal, the other amount is the PRA Forbearance amount. This amount is reduced to zero after a three-year period as long as the homeowner makes payments in full and on time. The government compensates the lender with an incentive payment between 6 percent and 21 percent of the principal amount reduced. The exact incentive amount depends on the amount of debt forgiven and the loan-to-value ratio of the mortgage.
