WABroker

Because of a decline in home values, many homeowners owe more on their mortgage than their property is worth. It can seem ridiculous to make mortgage payments on a house when a home estimator finds that the property is worth far less than you paid for it.

An upside down homeowner may already be behind on mortgage payments, which means foreclosure is lurking right around the corner.

However, a new principal reduction program can reduce the amount of money owed on the loan and eliminate negative equity. A principal balance reduction could allow homeowners with an upside down mortgage to avoid short sales and foreclosure.

Here's how it works.
An investor--in this case a hedge fund--agrees to buy the home loan from the bank at a discounted price. The lender may be willing to sell a mortgage in order to make money now, instead of waiting 30 years for the homeowner to pay it back or potentially lose money in foreclosure.

Once the hedge fund has acquired the home loan, the terms of the loan are revised, reducing the balance to 95% of market value. The interest rate on the loan is modified as well. By modifying the terms of the loan to reflect actual market value, the property gains equity.

To qualify for a principal reduction, the mortgage must be 25% more than the property value. So the mortgage must be upside down. In addition, the homeowner's debt to income ratio must be less than 51% based on the revised payment.

With a principal balance reduction, the homeowner essentially short sells the property back to himself with no tax implications or negative credit consequences.