| Friday, October 06, 2006 |
| Ouch! Your House Payment Just Doubled |
articles.moneycentral.msn.com
The mortgage party of 2003-06 is so, so over.
Darci Rickson now wishes that she'd looked closer at the fine print. So do Norman and Margaret Paige. And doubtless thousands of others -- soon to be millions -- whose cheap, fixed-rate introductory periods are about to expire.
The owners of about 7.7 million adjustable-rate loans taken out in 2004 and 2005 -- about $1.89 trillion worth -- face higher house payments in the next two to three years, says Christopher Cagan, the research director for First American Real Estate Solutions of Santa Ana, Calif. That's about a fifth of all mortgages outstanding in the U.S. right now.
These are not traditional mortgages. Rather, they are complicated, sometimes bafflingly intricate contracts loaded with changing rates and back-end details that trip up unsophisticated borrowers. One category, subprime loans, is aimed at the poor, minorities and people with bad credit -- in other words, those who can't, or think they can't, get a loan by other means.
Jordan Ash, the director of community activist group ACORN's Financial Justice Center in Minneapolis, blames the mortgage industry for aggressively marketing expensive loans that only the savviest consumers can understand to people with little money and flawed credit. "In the mortgage world, it's not a competition of who can give you the best rate -- they're all offering basically the same loans," Ash says. "It's who gets to you first and reels you in first. It's who has the best sales pitch."
The plain old adjustable-rate mortgage spells trouble enough. But three high-risk loans are causing most of the trouble:
·Teaser ARM. This loan features an alluring initial period of very low interest, around 1% to 2%, which later resets to market rates. About 1.4 million borrowers will be jolted back to reality in the next two to three years as their introductory periods expire. Payments on a $200,000 loan at 2% are about $725 a month; at 7%, they're $1,340.
·Subprime ARM. Nearly half of loans due to reset are aimed at low-income people, minorities and people with bad credit -- folks who can't or just assume they can't get a bank loan at a reasonable rate. Many are in a shaky financial position to begin with and so are in greater danger of defaulting. Subprime (also called nonprime) ARMs start high -- 7% or more -- and go higher. And higher. They often feature a fixed, lower-rate introductory period. But when that ends, it's "just the old-fashioned squeezarooni," Cagan says.
·Option ARM. This is the real killer. It gives homeowners the choice each month of paying the principal and interest, just the interest or an even-smaller minimum amount. Every month you pay the minimum, you're deeper and deeper in the red. And up to 80% of option-ARM buyers pay only the minimum, according to Fitch Ratings. Because the minimum payment doesn't cover the monthly interest, the deferred interest is added to the loan balance. After the loan balance grows to a certain point, the lender will demand that you start paying the full principal and interest -- on your now-bigger loan.
There are 400-odd varieties of mortgages, and some combine several nasty features in a single loan. One example: On a five-year teaser loan for $200,000 -- one with a 1.25% introductory rate, 7.414% fully indexed rate with a 2.75% margin and a 7.5% payment cap, if you're keeping score -- a homeowner could make minimum payments that rose from about $670 to $770 over the fixed term. At the end of five years, deferred interest would have inflated the balance on the loan to nearly $220,000. The new monthly payment, one that paid back all the interest plus the principal? About $1,600. Is there any wonder why buyers are confused?
"The products are getting more and more complicated, and it's harder and harder to understand them and make an informed choice," Ash says. "Lots of people did not know what they were buying. I had one person who came and said, 'I make my payment I every month, and every month my loan goes up. How can that be possible?'"
How could things be worse? Easy: Many of these loans also have prepayment penalties, so you're nailed with fat fees if you try to refinance or pay off the balance early.
Cagan, who conducted a February 2006 study, "Mortgage Payment Reset: The Rumor and the Reality," predicts that the U.S. will weather this mortgage problem, but he's not saying it'll be easy. It's a bump, not a catastrophe, for the economy, he says.
The story of a home
So far, just the homeowners who bought these cheap loans early, or whose introductory periods were short, have been hit. "We haven't had a lot of people lose their houses to reset yet. That's proof it hasn't really bit yet," Cagan says.
But Norman Paige knows better: He and his wife, Margaret, have seen their mortgage payment go from $729 a month -- at a fixed rate of 7% in 2003 -- to $956 a month today, after their fixed-rate period ended in 2005.
The Paiges bought their home in 1974 with a government-assisted loan for veterans. They reared three children there and over the years refinanced it three times to pay for repairs and upgrades. Paige has lost track of how much equity they have in the house.
The Cleveland-area residents recently filed for bankruptcy and relinquished a rental house to foreclosure, so Paige doubts he could refinance again. "There's nothing I can do now," he says, but devote more of their $4,200 monthly fixed income to housing and be grateful that his pension is a good one. He is kicking himself: "I just got messed up. You want to get mad, but you can't get mad at nobody but yourself."
Foreclosures in the U.S. jumped 24% from July to August. The 115,000 foreclosure filings in August were "the biggest spike we've had all year" -- a 53% increase in foreclosures from August 2005, says Rick Sharga of Realty Trac, an online foreclosure marketplace. "The fact is, we've never had this many of this type of loan mature all at the same time, so there really is not a precedent for this."
Who's most in danger?
People who borrowed before 2003 are safest from the mortgage-reset problem, Cagan says, because they probably have built up equity that will help them refinance or, at worst, sell without losing money -- unless they are in a stalled real-estate market, that is.
But those with no equity are in riskier terrain. It's the people without equity who are in trouble: "You get into the situation where you can't sell, can't refinance, can't negotiate," Cagan says.
In 2005, he says, 29% of mortgage holders had no equity or, because of borrowing, owed more than their houses were worth, a situation known as negative equity. Nearly 11% of those with negative equity were down 15% or more below their home's value.
The Paiges did their borrowing from finance companies, whose higher-price loans target the subprime market -- those borrowers with less-than-sterling credit. But in the beginning, could not this career government worker with a working spouse have qualified for a bank loan at an affordable rate? "I never really thought about going to the bank, to be honest," he says.
Paige, like many who bought subprime or teaser mortgages, says he did not fully understand what he was buying. ACORN, the Association of Community Organizations for Reform Now, studied the problem ("The Impending Rate Shock: A study of home mortgages in 130 American Cities") and concluded: "America's lower income and minority communities receive a disproportionate number of subprime loans and thus are most at risk of increased defaults and foreclosures." Irrespective of income, minority homeowners "are often steered into ARMs without being given a choice and have little knowledge of how ARMs work or the risks associated with these loans," the ACORN study says.
ARMs and their risky cousins
Darci and Jim Rickson can say just how tough things can become for borrowers with subprime loans. Darci, 35, and Jim, 37, were "just a young married couple" three years ago when they came into a $10,000 inheritance. As she recounts it, their credit "wasn't the best." She'd finished a repayment program the previous year to retire $15,000 in credit card debt. He simply had no credit. Still, "interest rates were low, and everyone -- our parents, friends of the family -- were telling us to buy instead of rent."
With the inheritance for a down payment, they bought a three-bedroom, two-bath house in Topeka, Kan., for $92,000. Banks wouldn't pre-approve them, but they found a mortgage broker to work with. They bought an ARM. "At first, I thought she was going to get us 7% or 7.5% -- almost 8%. And then when we went to sign the papers, it was 9.75%," Darci Rickson says. "It was, oh, she couldn't get that one, she could only get this one. I didn't know enough to look around."
ARMs have been around for decades, but as recently as 1999, just half of subprime mortgages were ARMs. Now, however, ARMs -- though roughly a quarter of all U.S. mortgages -- account for three-quarters of subprime loans, according to the ACORN study.
ARMs became popular in the housing boom partly because borrowers can use them to qualify to buy more house than they otherwise could, thanks to ARMs' initial payments that are lower than those of fixed-rate loans.
A disproportionate number of ARMs now are sliding into foreclosure, says RealtyTrac's Sharga. He says his company has begun a nationwide analysis of foreclosures by looking at Cook County, Ill., which includes Chicago. There, "about 57% of the foreclosure properties were on some sort of adjustable-rate mortgage," Sharga says. "If that's any indicator, it suggests we could be in for a rough ride for the next couple years."
At first, the Ricksons' ARM, with its $829 payment, seemed affordable. Jim Rickson is a carpenter, and Darci Rickson was a stay-at-home mother with two preschoolers. After the two-year introductory period expired, the Ricksons figured, they'd refinance into a lower rate. The important thing was to get a toehold in the housing market.
The 14.75% mortgage
Adjustable-rate loans frequently are marketed with the idea that the homeowner can use the introductory period to improve bad credit, then refinance the home into a fixed-rate mortgage when it ends. But as the Ricksons discovered, trouble can throw that plan into chaos for families without a fat emergency account.
Jim Rickson lost his job, and the couple fell behind on the mortgage. Their broker called two years later, as promised, to discuss refinancing, but by then their credit was shot. They are now stuck with the ARM, which left its two-year fixed-rate period and is rising every six months. In June, it went to 14.75% interest -- $1,162 a month.
Such loans can work for some savvy buyers intending to hold a house for a short time, then sell it, or for people who will make substantially more money in a couple of years. Attentive, sophisticated consumers can enjoy the low rate, then refinance into a fixed mortgage. But it's a gamble. When introductory periods end, the adjustable rate is tied to the prevailing cost of money -- and more. If you're a law student who is soon to graduate into a fat salary, good for you. But if you stretched your income to the max to afford the introductory payment, you'll be in deep water.
"If you are paying 30% of your income just for the minimum (payment), and it doubles, it's pretty obvious that a family can't pay about 60% of their income on housing," Cagan says.
Six months behind on the mortgage and faced with foreclosure, the Ricksons filed for Chapter 13 bankruptcy in 2006. Now, Jim is back to work, but it's a fragile time. "If we miss a payment, within 15 days, they're taking our house," Darci says. The goal is to make 12 consecutive payments on time, after which they intend to ask the court to release the house from the bankruptcy so that they can try to qualify for a new, lower-cost loan.
To deal with the higher payments, Darci found a half-time job she can do nights and weekends. She trades with other mothers for hand-me-downs rather than buying new clothes for her kids. Instead of salon haircuts, a friend cuts her hair. The Ricksons cook at home more, and, if they eat out, it's from the McDonald's dollar menu.
"When we bought this house, we didn't have student loans, we didn't have credit-card debt, we saved our money, we figured out what we could pay. Now, here we are -- we're scrambling," Darci Rickson says. The couple is on track, though: "We've made five months in a row. We just need to get seven more, and yet the interest is going to go up again in January."
If your payment jumps
Here's what to do if you're caught in the trap:
· Move quickly to refinance. If you've got the credit needed to refinance, this is an excellent time for it: Rates are historically low in general, and they've dropped a half-point since a recent peak to 6.31%, according to Freddie Mac's Primary Mortgage Market Survey. The low point was 5.23% in June 2003, but mortgage rates have bounced around plenty since they began dropping from 7% in early 2002.
· Act now. It's emotionally difficult to act when you're in a financial hole, but the sooner it's done, the smaller the damage. Plus you'll feel better when you start working on the problem. Start by calling your mortgage lender to learn their offerings. Mortgage retailers currently are eager to refinance adjustable mortgages into fixed loans.
· Don't stop there. Don't assume you can't get a better rate. Call lots of banks and mortgage brokers to learn all your choices.
· Admit defeat. If you are simply over your head in your mortgage, read "Facing foreclosure? 9 options" to learn what possibilities are open to you.
· Learn a little. You don't need to get a college degree in mortgage finance to pick up some consumer smarts in this area, but taking out a mortgage does require your attention. Start here and here and keep searching and learning.
· Get help in this tough, complicated world. Find a trustworthy, nonprofit credit-counseling agency near you here. For fellowship and a shoulder to cry on, consider talking it over with other MSN Money readers at the Your Money message board.
Marilyn Lewis is a free-lance writer based in Western Washington. |
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