The Mortgage Crisis- What Some Just Don’t Understand

We’ve all heard the stories about people getting into a mortgage without reading the fine print, or simply buying a home that they can’t afford. But the truth of the mortgage crisis, in my opinion, dives much deeper than that, and was undoubtedly brought on by the mortgage industry and the basic human need of “keeping up with the Jones’”.

First of all, we have adjustable rate mortgages that are about to expire. Many think that an ARM (adjustable rate mortgage) may in fact lead to a rate reduction if interest rates and whatnots drop when the terms of their mortgage expire, typically one, two or five years from the date of their first payment. The truth is, rates will not go down. In fact, they will go up an average of 3-full percentage points on the first hit and up to 2.75 more (yes, additional) in another year or two. This means that if your ARM mortgage has a 6% annual percentage rate (APR), your interest rate will immediately increase to 9%, followed by another blow in a year or two, depending on your program, to 11.75%. Yes, the mortgage payment could nearly double.

Next on the list of problems is the pre-payment penalty. Nearly every state allows these to be part of your original mortgage agreement, while some states (like Massachusetts) have laws against them. What this means is that if you pay off your mortgage early, usually by refinancing or winning the lottery, you will be hit with a financial penalty, perhaps 6 months equivalent of your principal and interest payment (your mortgage payment minus escrow for property taxes and hazard insurance), or maybe even a percentage of your balance owed. Translated into English, if your mortgage payment, leaving out your escrow amount, is $1,200 per month, your penalty for paying off your note early by refinancing could be $7,200. If your balance is $200,000 and your penalty is based on your balance owed, say 5%, your pre-payment penalty would be $10,000.

The real kicker of the above two is the fact that your ARM mortgage will probably expire at the exact moment o your pre-payment penalty. Now you have to time your refinancing perfectly so that you don’t have to pay the pre-payment penalty AND before your ARM rises.

Next, we have the problem of falling equity. If you bought your home 2 years ago, you have probably lost some money in its equity. Let’s say that you bought your home for $250,000 in 2006. Right now, due to the slowing market and abundance of homes available, your property value is probably around $210,000 or $220,000. Now besides having to time your refinancing quest to not pay a heft penalty and avoid a rate hike, your home’s appraisal comes in significantly lower than what it did in 2006. If the balance on your home is $220,000, and the appraisal comes in at $210,000, you now have the problem of refinancing a mortgage that’s higher than your property value.

Imagine having to pay a $7,200 penalty on top of your $220,000 mortgage balance on a home that’s worth $210,000. Oh, and don’t forget about the lender’s fees for completing your new mortgage application and any other closing costs that you’ll have to pay, averaging around $7,000. So, you have a $220,000 mortgage balance, a $7,200 prepayment penalty combined with your new closing costs of $7,000. You are now refinancing $234,200 on a home worth $210,000. Good luck with that.

Now, let’s say that you’ve passed the time in which a pre-payment penalty would be in effect, but you were unable to (or unknowingly) able to refinance your home. Your mortgage payment skyrocketed 50%, say from $1,200 a month to $1,800 a month. Times get really tough. The rising prices if fuels for your car and home-heating oil leave you trapped. You cut coupons to help with the rising costs at the supermarket, as their costs have increased too, because you now have to pay for the rising price of fuel to get the products on the shelves and to heat their store. You fall behind on your mortgage by just one month. Your credit score drops incredibly because of the ill-fating timing of everything happening at once. You now need to refinance your $220,000 mortgage and $7,000 in closing costs on property that’s worth $210,000, with a late mortgage payment on your credit report. Good luck with that, too.

The feds are working on some ideas to help those in trouble with their mortgage. But are they being designed to help the individual homeowner, or to help the lending institutions? My next post will be on the ideas the feds have and what you can do to make sure they choose the best plan to help US!