Foreclosuremania

There is probably little as traumatic as losing your home, for any reason. But losing it to foreclosure is especially painful. There isn’t much one can do about a fire or flood, but foreclosure feels like a personal failure. This year will, no doubt, go on record as one of the worst years for foreclosure since the Great Depression. However, during the depression the broken economy caused all sorts of ugly things to happen. Bank failures, catastrophic unemployment figures, but how do you explain this now, when the economy appears strong and improving?

Of course, there are the standard reasons. You lost your job or over extended financially – unfortunately these situations have always caused foreclosure and always will. What we are experiencing today is something else, brought about by careless and ill-informed consumers and new mortgage products that don’t sufficiently consider economic cycles and an individuals’ ability to adjust to them.

The first mortgage program that offers you the ability to find yourself in the jackpot is the adjustable rate mortgage (ARM). This program is very straightforward, has some precautions built into it and can be really beneficial if understood and used properly by the consumer. The rules are clearly outlined within the ARM program, there are limits as to how much the rate can adjust at each adjustment period, as well as over the life of the loan. Typically, the lifetime increase would be no more than 6%, so if in the first year you received a rate of 5%, you would know that over the life of the loan it would never be worse that 11%. Pretty high, but at least a known commodity. So the wise advice here would be to ask your mortgage provider to calculate your payment at 11% as well as 5%. You would then know the worst case and if it appeared to you that there would be no way for you to afford the highest payment then this may not be the mortgage program for you. As interest rates begin to rise and adjustable loans begin to adjust, many people are finding themselves unprepared. There is no reason for surprise, after all you knew the end at the beginning.

ARMs are especially well suited to folks who don’t intend to stay in the home very long. ARMs come in several varieties, based on their adjustment period. A one-year ARM has the ability to adjust each year, a 3-year ARM adjusts after 3 years, a 5 in 5 years and so on with the 7- and 10-year ARMs. If you know that you will only be in this home for 4 years, then a 5-year ARM probably suits you. If you think you will be in the home for the duration, then you may not want a mortgage that adjusts annually.

Of course interest only loans can also be problematic, in that although you are paying your interest in full annually, you are making no progress against the principle. So after paying interest on your $100,000 mortgage for ten years, you still owe $100,000. This isn’t necessarily a problem if property values in your community rise annually. However, there are communities across the country that are feeling an appreciation pinch and in those communities you may end up owing more than you can realize from a sale. Under those circumstances, some individuals opt to let the home go to foreclosure rather than come up with a lump of money to sell their house.

The next product we want to consider, comes with numerous labels – the option loan or the choice loan – but the structure is that each month the borrower is given the option of making a payment based upon their adjustable start rate, or an interest only payment, or a 15-year amortized payment, or a 30-year amortized payment. Managed properly it can actually be a very useful tool. It is especially good for the self employed or commissioned sales people who don’t always know what their income will be from month to month. In months when your income is good you make the 15-year amortized payment and in months when things are running a little leaner, you make the interest only payment or perhaps that low, low start rate payment. Where the consumer gets themselves in trouble is when they make a practice of making the lowest payment month after month. This payment is less that the interest only payment, therefore, you are not even making the interest payment on the loan, in which case you are subject to negative amortization. This simply means that rather than your loan amortizing in the normal way, (becoming smaller month after month), it is growing month after month, because the interest you are not paying is being added to your principal.

There are many other loan programs that we should be covering here. Time and space won’t allow this, so let me end with two final thoughts. Programs that allow for 100% financing and programs for folks with “less than perfect credit” are dangerous from the perspective that the consumer often has little to lose if they find themselves in serious financial trouble. And finally, remember that the last thing a lender wants is your home. They are inclined to try to work with you to reverse your situation, so don’t be afraid to open a dialogue with your lender to see what you can work out. I guess in the final analysis the best advice I can offer is – if you don’t think you can handle the debt, don’t borrow the money.

Gary Straub is the AVP for mortgage production with Fifth Third Bank of Western PA and has been a real estate professional in the Pittsburgh area for 35 years.