The Mortgage Guide

Over the past few months Countrywide Home Loans, Lehman Brothers, and Merrill Lynch’s First Franklin to name a few have all announced major employee cutbacks. President Bush also recently announced a foreclosure avoidance initiative. And talk of an imminent mortgage crisis permeates the media. So how serious is the threat of foreclosure?

From: The Associated Press
First American CoreLogic, a research firm affiliated with LoanPerformance, predicts about 1.1 million ARMs totaling $325 billion will sink into foreclosure as rising monthly payments squeeze borrowers. approximately 1.1 million homes will be foreclosed on with losses exceeding $100 billion over the next six years.

Although foreclosures represent less than 1% of total lending and won’t destroy the mortgage industry at current levels, foreclosure rates are rising. Serious delinquency rates (rates of homeowners 60 days behind on their mortgage) are also on the rise. So what do homeowners need to do up front to steer clear of foreclosure danger before they get anywhere near it? The answer is to avoid 6 types of loans.

1. Subprime Loans

   The first of these loans to be avoided is the subprime loan. Just a few years ago, lenders offered a wide variety of loans to customers with poor and no credit histories. What’s more is that customers with low credit ratings were able to purchase homes with little or no down payments. Just because you can qualify for a mortgage doesn’t mean you are ready for it. Over the last two years foreclosure rates have remained about the same for homeowners with “Prime” mortgages. However, foreclosure rates for “Subprime” homeowners have steadily increased.

2. High Loan To Value (LTV) Loans

   The second type of loan to be avoided is the low equity loan. Lenders refer to these loans as high Loan to Value (LTV) loans. For example, if your home is worth $300,000 and you own $270,000, then your LTV would be 90 percent. The higher the LTV, the less equity the owner has in the home. Equity is important because it provides a cushion if the owners fall behind on payments and decides to sell their home. This is most important in areas where property values are falling. Some owners owe more than their homes are worth. And borrowers who owe more than the value of their home are 6 times as likely to be 60 days delinquent on their mortgage payment as owners who have 20-30 percent equity in their homes.

3. Interest Only Loans

   The third type of loan to avoid is the interest-only loan. In some metropolitan areas like San Francisco, more than 60 percent of new homes were purchased with Interest-only loans. And since 2003 the number of interest-only loans used for purchases has risen 20 percent across the board. Interest-only loans have allowed thousands of families afford homes and mortgages that they otherwise could not, especially in areas with rising housing costs. The problem is that borrowers can only delay principal payments so long before they will be, in effect, renting their homes. In a few cases, borrowers choose interest-only loans when they can’t afford the fully amortized payment.

4. Negative Amortization

   The fourth type of loan to avoid is the negative amortization loan. This loan is meant to be used by a few specific types of people. For example this loan is meant for people who are disciplined in their spending but have big swings in their income. This allows people to make the minimum payment during lean months or pay extra principal during more lucrative months. But borrowers who can only afford the minimum payment will find themselves in serious trouble when the introductory teaser rate expires. Some projections indicate that 32 percent of these loans will default because of resets to the teaser rate.

5. Loans in Markets With Falling Values

   The fifth loan to avoid is any loan in an area where property values are falling. Housing prices play a major role in projecting foreclosure rates. For each one-percent fall in national housing prices an additional 70,000 loans will enter foreclosure.

6. Any Combination of the Above

   The sixth and most important type of loan to avoid if you want to avoid foreclosure is any combination of the loans mentioned. Combining any of the above types of loan layers levels of risk on top of each other.

Overall, it is most important for borrowers to balance cash flow needs with an acceptable level of risk. And before signing for an adjustable rate mortgage, borrowers should consider what the payments will be after the initial period. Traditional adjustable-rate mortgages, interest-only mortgages, and even negative-amortization loans are all excellent mortgage products when fully understood and used wisely. And for those borrowers who are already behind on their payments or actually in foreclosure, there are still options.

Categories: Featured, Foreclosure, Housing Market
Tags: Features, Foreclosure