Dealing With Mortgage Payment Woes
The Early Show's resident money maven, Ray Martin, explores the jump in the number of homeowners having difficulty making their mortgage payments, and offers advice that could help them in those efforts.
Credit Crunch in Mortgage Market Squeezing Borrowers
Over the past decade, the home ownership rate surged from 65 percent to over 69 percent, fueled in part by the seemingly never-ending rise in home values and fountain of mortgage loans.
According to a study by the Federal Reserve Bank of Chicago, about half of all this increase was attributed to subprime lending.
Subprime loans — home loans made to people with poor or checkered credit histories — made up about 12.75 percent of the mortgage market in 2006, up from 8.5 percent in 2001.
At a time when home values were surging in many markets, mortgage lenders raced to compete with each other to offer loans with low teaser rates, piggyback loans (two or more loans used to buy a home), no-money-down loans, and "no-doc" (no-documentation) loans – which allow the borrower to state their income and assets without requiring any proof or documents.
Of course, all of this easy credit created lenders' profits fueled by added costs to borrowers: high origination fees and interest rates often two-to-three percentage points higher than the rate for borrowers who have good credit and do not need to rely on such terms to get a home loan.
But now, these "high profit" loans are creating problems. According to the Mortgage Bankers Association, the percentage of mortgages in which payments are delinquent has risen nationally to 4.7 percent, the highest level since 2003.
A closer look reveals that mortgage defaults and delinquencies for "subprime" mortgages is 12.7 percent, up from 11.7 percent in the second quarter of 2006. Some lenders who made such loans are being required to take back loans where the borrower is late or no longer making payments, resulting in serious financial trouble for these lenders.
Exploding ARMS and Liar LoansClick Here to visit CBSNews.com's real estate section
Today, about 80 percent of subprime mortgages are adjustable rate mortgages, or ARMs, also called "exploding ARMs." These loans are so-named because they carry low teaser rates that often reset dramatically higher, increasing the borrower's monthly mortgage payments by 25 percent or more.
According to reports from loan counseling agencies across the nation, the main reason homeowners give for falling behind on their mortgage payments is not a change in personal circumstances (such as a job loss), but instead, they are not able to make the increased payments on their ARMs.
The loan application and review process for "no-doc" loans was so lax that such loans are referred to as "liar loans." In a recent report by Mortgage Asset Research Institute, of the 100 loans surveyed for which borrowers merely stated their incomes on loan documents, IRS documents obtained indicated that 60 percent of these borrowers overstated their incomes by more than half.
The newer mortgage products, such as "piggyback," "liar loans" and "no doc loans" accounted for 47 percent of total loans issued last year. At the start of the decade, they were estimated to be less than two percent of total mortgage loans. As a result, homeowners have never been more leveraged: The average amount of debt as a percentage of a property's value has increased to 86.5 percent in 2006 from 78 percent in 2000.
Credit Crunch in the Mortgage Market
So far, the mortgage industry troubles seem to be concentrated in the subprime market, where lenders made loans to people whose credit histories indicated their inability to make loan payments on time. But lending to low credit score borrowers or those without documentation wasn't the only underwriting stretch.
More trouble has been experienced by lenders who made subprime loans as second mortgages, which were made at the time of the first mortgage. These loans are called "piggyback mortgages" and are typically smaller and usually used to provide the additional cash needed by the borrower when the first mortgage is not enough. Typically, when a borrower is having trouble making payments on both loans, the "piggyback loan" is the first to be paid late, if at all.
Typically, lenders plan for some volume of loan defaults with reserves, insurance, or other strategies. But when the volume of loan defaults rises significantly, their insurance costs rise, cash reserves and funding dry up, and they have no other option but to go out of business. In fact, already, more than two dozen mortgage lenders have failed or closed their doors as a result of their trouble in the "subprime" mortgage market.
The institutions that make up the industry of mortgage lenders are reacting by tightening or restricting the terms of loans they will make. In a recent survey of bank loan officers by the Fed, some 16.4 percent of lenders reported they have already tightened their lending standards. Examples of such tightening include:
Many folks may say good riddance to these loan practices and that the lenders and borrowers who get into trouble with these loans are getting the day of reckoning they deserve. But anyone who owns a home and is looking to sell or refinance a loan should be concerned.
Tighter credit means fewer potential buyers, fewer buyers means less demand, less demand means less appreciation. Add a growing volume of homeowners who now owe more than their homes' value and who have no viable options for refinance or repayment and you have the conditions for more folks who will simply opt to walk away, forcing the lender to foreclose and sell at a below market price. This could make it more difficult for "innocent bystanders" to sell their home or refinance a mortgage.
Options for Borrowers with Option ARMs
Most home buyers should never use a payment option ARM, a type of ARM that allows the borrower to make a regular payment or a payment that doesn't even cover all the monthly interest. If you have an Option ARM, you need to know the risks and how to protect yourself:
Pick-A-Payment Wisely: As tempting as it may be, avoid paying the minimum monthly payment. At a minimum, pay all of the interest due. Also, read the terms of the mortgage carefully so you understand when your mortgage will "negatively amortize" and when your mortgage can be "re-cast," which would result in a higher payment.
Call Lender Before Payments Are Late: If you know you can't make timely payments when your ARM payment increases, don't wait until after you've missed a few payments to discuss your situation with your lender. Your lender should be interested in keeping loans from going into foreclosure and may be able to work out a deal with you. For example, they may offer a three-month grace period during which the payments are added to the loan balance, or they may offer to modify your loan by locking in an interest rate.
Refinance to Fixed Rate Mortgage: For many with Option ARMs, it may be better to refinance to a fixed rate mortgage, in which the payment will be higher but never changes, rather than continuing with an Option ARM and dealing with the inevitable shock of a payment that is even higher. But, carefully check the current mortgage for additional fees that may apply during a pre-payment period, which could be up to three percentage points of the mortgage amount. Also, there are closing costs to pay when refinancing a mortgage. If you do refinance, ask your new lender about Streamlined Refinancing, in which the new lender uses the paperwork, appraisals and documents from your prior mortgage, to reduce the closing fees.
Consider Refinancing Alternative: Some mortgage lenders are offering alternatives such as Loan Modification, in which the lender offers to change your current mortgage from an ARM to a fixed-rate loan for a fee of a few hundred dollars. While the interest rate might be slightly higher than what you could get if you shopped around for a new mortgage, the savings in closing costs can make up for it.
Cancel Unnecessary Fees: If you originally made a down payment of less than 20 percent, then you are probably paying Private Mortgage Insurance, or PMI, with every monthly payment. If you live in an area where home values have appreciated since your took out the mortgage loan, it may be worth looking into cancelling the PMI. If your home's value is such that your current mortgage balance is only 80 percent or less than the value of the home, then you might qualify. Your lender may require you to get a re-appraisal of your home, which may cost you a few hundred dollars, but that could save you a few hundred dollars a month if you get to cancel the PMI.