Interest rates on about $1 trillion in adjustable-rate mortgages are headed up by the year's end. If your loan is among them, this five-step game plan might save you a lot of grief.
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July 26, 2007 -- 09:40 ET
By Liz Pulliam Weston
The young woman just wasn't getting it.
She called Consumer Credit Counseling Service of Nevada and Utah for help managing her family's mortgage payments. A year ago, a mortgage broker had persuaded her to refinance the family home, pull out all of the equity and invest the cash in a rental property. Now both mortgage payments had reset to much higher levels, with the interest rate on the rental jumping from 1% to more than 8%.
She couldn't afford either payment. Michele Johnson, the CEO of the counseling service, remembers the woman pressing for a way to keep her home, but there wasn't one. The problems were that:
Both properties had lost value as Las Vegas' real-estate bubble popped. The woman owed more on the homes than they were worth, so lenders wouldn't refinance the loans.
So-called rescue funds, set up by some states and some lenders to help victims of predatory lending, had far more applicants than funds, and they weren't available in her case anyway.
A bankruptcy filing, touted by attorneys in television ads as a way to "fight foreclosure," would just put off the inevitable.
The woman's only option for avoiding foreclosure was a short sale, in which she might persuade a lender to accept the sale proceeds from both properties and forgive the rest of her debt. But, Johnson said, the woman didn't want to hear that.
"People have this unrealistic viewpoint that 'this is my home; I'm not going to lose it.' It all becomes very emotional," Johnson said. "Listening to facts and figures is not what they want to hear. They want a rescue."
Don't delay If your loan is among the $1 trillion in mortgages scheduled for payment increases by the end of the year, ignorance and denial are not your friends. You need to take action, and the sooner the better:
If you've still got some equity in your home and the ability to handle a larger payment, you may be able to switch to a smarter loan.
If your situation isn't as rosy, quick action can contain the damage to your personal finances.
Here's your game plan.
Know where you stand. Dust off your mortgage documents, advises LendingTree.com chief economist Jim Svinth, and scour them for important information, such as:
When your payment is scheduled to adjust.
What benchmark the payment will be based upon (such as the LIBOR rate or the one-year Treasury).
What your margin is (this is what is added to the benchmark to determine your new rate).
What your caps are (many adjustable loans typically can increase no more than 2 percentage points in a year and 6 percentage points over the life of the loan, but check your documents to be sure).
You can find the most recent benchmark rates at HSH Associates' ARM index page. Once you know what your new interest rate is likely to be, you can use HSH's amortization calculator to determine what your new payment would be.
Math-challenged? You may be able to simply call and ask your lender or loan servicer, if they're not too busy handling all the folks who have already defaulted.
You also need to find out whether you would face a prepayment penalty for refinancing your loan. Prepayment penalties are unfortunately common on loans extended to people with troubled credit, and until they expire, they can make a refinance harder to justify financially.
Your future is tied to your past Get your credit reports and FICO credit scores. Your options will be dictated in large part by those scores, said credit and mortgage expert Gerri Detweiler of FreeRateSearch.com, particularly if you don't have much equity in your home or can't document your income with tax returns or other proof. You generally need a score of 700 or better to get the best rates and terms. If your scores are 660 or below, LendingTree.com's Svinth said, you'll face more scrutiny from lenders and have a tougher time getting a loan.
This is a big turnaround from a year ago, Svinth said, when lenders were falling over themselves to give no-down-payment and no-equity loans to borrowers with credit scores below 620 and income they couldn't or wouldn't prove.
"We've gotten back to basics," Svinth said. "Credit and collateral matter now."
Someone with credit scores in the 700s who is able to document his or her income and who wants a loan for 95% or less of the home's value "has plenty of options," Svinth said. "It's the ones with poor credit who want a 100% stated-income loan. . . . I'm not saying there are no options, but they're going to be expensive."
You can get your credit reports once a year for free from AnnualCreditReport.com, but scores are not free. To get FICO scores, which are the same scores mortgage lenders use, you'll need to pay about $50 at MyFico.com, the only site that sells FICOs for all three bureaus. Mortgage lenders typically base their decisions on the middle of the three scores, or the lower of the two middle scores when lending to a couple. You also can get an approximation of your scores with MSN Money's credit-score estimator.
You may be able to boost your scores by successfully disputing serious errors on your report, such as accounts that aren't yours or late payments that actually were made on time. Another tactic for quick score improvement: pay down credit card balances and use your cards lightly. The less of your credit limits you use at any given time the better. Using 30% or less of your credit limits is good; less than 10% is even better. Because balances are reported monthly, improvements in your scores should show up quickly. Read "7 fast fixes for your credit score" for more tips.
Get real about your equity. Refinancing to a different loan will be tough, if not impossible, without at least some positive gap between what your home is worth and what you owe. Home-value estimators such as Zillow, RealtyTrac and Domania can get you started, but you may get a more accurate figure by talking with several real-estate agents who are familiar with your neighborhood. If home prices are dropping in your area, understand that lender appraisals may be getting more conservative as well.
Start shopping. If you can refinance, your next step is deciding whether you should. You can research your options at FreeRateSearch.com, LendingTree.com and other sites.
What you should do next depends on the specifics of your situation.
If your current, fully indexed rate is significantly higher than the rate you could get with a no-cost refinance, mortgage expert Jack Guttentag recommends jumping to a new loan, assuming there's no prepayment penalty. (Guttentag's site, the Mortgage Professor, includes an article about whether to refinance an adjustable rate into a fixed-rate loan, as well as other information about refinancing.)
If the new rate isn't much better, though, and you can handle the bigger payment, you might just stick with the loan you have, Guttentag said.
"Ninety-nine percent of ARM borrowers approaching a rate reset face a rate increase," said Guttentag, "but it could be small, and if there is a prepayment penalty, it might not pay to refinance."
Detweiler, of FreeRateSearch.com, votes for fixing your rate if you can. She notes that rates, though higher, still are near generational lows, and she thinks the gap between fixed and adjustable rates isn't great enough to justify going with an adjustable loan's greater risk. That's true for folks with good credit as well as for those with troubled credit.
Here's an example. Someone who in September 2005 opted for a two-year hybrid mortgage for $250,000 and who had a credit score of 615 could have qualified for a loan with a payment of about $1,579 a month. In September 2007, the payment on his loan would be scheduled to rise to $1,906, a 21% increase.
Because rates have risen overall, jumping to another two-year loan wouldn't save much: less than $100 a month. Switching to a 30-year fixed rate would, by contrast, result in a payment of about $1,881 a month, just $60 more than the two-year hybrid.
Can't cope? Talk to a housing counselor. If you think you can't swallow a bigger payment and you have no equity in your home, Detweiler said, it's time to call for help. A HUD-approved housing counselor can discuss your options and offer budgeting assistance to see whether there's a way to handle the new payments.
If not, your last best hope may be selling the home before foreclosure. Read "Facing foreclosure? 9 options" and "Your lender doesn't want your house" to better understand your alternatives when you're facing default.
Columns by Liz Pulliam Weston, the Web's most-read personal finance writer, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.
Published July 26, 2007
E-mail me at RealtorChris@msn.com
Thursday, July 26, 2007
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