Is Your Mortgage Risky?
With Rising Delinquencies in Mortgage Payments Across the Nation, Here's How to Tell if Your Mortgage is Risky
You've seen the news lately-mortgage lending companies' falling stock prices, rising delinquencies-and you might be tempted to think of these things as someone else's problems. After all, it's the people with the worst credit who are now falling behind in their payments, right?
What Type of Mortgage do You Have?
Borrowers beware: if you currently hold a mortgage where the payment changes over time, or the terms of the mortgage change over time, you should be asking yourself some very important questions. You need to know whether you might face an increase in your monthly payments that would cause difficulty for you and your finances. You need to determine if the terms of your mortgage could ruin you in the near future. It's not as unusual as you think, even amongst borrowers with better credit history or higher income than average. Exotic mortgages and looser lending policies that have led to trouble for many borrowers and lending companies have also pulled in people with better credit and higher incomes. It's not just those with bad credit mortgages and low income mortgages that are now feeling the misery. As terms on exotic mortgages change, resulting in higher payments for the most part, anyone holding an Adjustable Rate Mortgage, for example, will feel pain.
The initial cheap monthly payments offered by Adjustable Rate Mortgages were the only way for some people and families to afford buying the dream home they wanted but never thought they could afford. And ARMs made it possible. Other borrowers who had equity in their primary residence used that equity to buy a second home or to pay for renovations or to buy something else, or to invest. If the mortgage they took out was an interest-only mortgage, then they haven't gained one penny of equity since they took out that loan. Sometimes interest-only loans don't require payments on the principle for years and years. These people will see spikes in their payments sometime down the road, and they too will feel the misery. People who took out a Jumbo Loan, which is a loan for more than 417,000 for the year 2006, will have even more troubles, since their loans are of much greater scale. And right now is when the pain is beginning for the many people who took out ajustable rate jumbo loans two or three years ago.
Borrowers aren't the only ones feeling the pain. Companies in the mortgage business have been taken down a rough road lately, with rising delinquencies and falling stock prices. Some are no longer offering subprime loans, and others aren't even offering loans at all anymore. The business of subprime lending has taken a dramatic U-turn lately.
Pay Attention to Your Home Loan
People spend lots of time researching their investment portfolio and making educated decisions about where they invest their money. Oddly, it's not unusual for people to have much more invested in a home than in the stock market, yet they dont' spend any time at all anayzing their mortgages. That's unbalanced priorities, since more often than not, the home mortgage is far bigger of an investment because the balance is much greater. If you have a mortgage where the payment can change, then you should immediately start researching and learning about your mortgage, your options, and your personal finances. Don't make the mistake of thinking that you're exempt from foreclosure just because you have good credit or you bring in a large salary. Even wealthy individuals experience foreclosure.
What Can You Do?
First of all, get rid of your adjustable rate mortgage. Get yourself into a fixed rate, 30-year mortgage. Second of all, find out if you are in danger of falling behind on your mortgage payments. To do this, ask yourself three questions.
What percent of your income are you spending on your mortgage payment?
The rule of thumb for a safe percentage is 28% of your pre-tax income going towards housing. That includes the pricipal and interest in your mortgage payment, property taxes, and homeowners insurance. If these costs add up to more than 28% of your income before taxes, then you are probably paying too much, and you are at risk of default. Lenders use the 28% figure in determining how much loan to grand borrowers, but in the housing boom of this century, many lenders have upped the 28% benchmark. They offer loans where the borrowers ends up paying 40 to 50% of their income on the mortgage payment. That can catch up to you after just a few unexpected bills or financial emergencies. Remember, you're talking must 28% of your pre-tax income. You still have to pay around 30 to 40% of your income to taxes and a 401(k), then your living expenses. If your mortgage payment shoots upward, your budget for daily living and emergencies is getting squeezed tighter and you are more vulnerable.
What happens if a string of catastrophic events take place?
Everyone needs to have a savings account and an emergency fund. You never know what life will bring you, and if you're spending too big of a chunk on you housing, then you can't face what comes your way. Imagine a series of unfortunate events beyond your control. Let's say we have a family with an interest-only mortgage. This means that although for years they've been paying a monthly mortgage payment, they haven't paid downt he principle one bit. Once the monthly payment will reset to higher amounts, they will begin to chip away at their loan. They feel confident they can handle future higher payments because the wife has a solid, well-paying job and the husband is just about finished with law school. He hopes to also make a solid income, and chances are good. Take a look a few years down the road and now the couple is getting divorced. The husband doesn't like practicing law or he can't find a good job. Or, even if the family is still together and both adults have good jobs, say a child gets seriously ill. These unforseen events make that higher mortgage payment a real hardship. They can't make the payments so they need to move to a smaller, cheaper house. But now the value of the house has fallen and they can't move right away. Does the family have enough in the bank to weather this storm? Can they survive a few months until the house sells, or they cover the medical expenses, or one divorced spouse covers the payments alone? You have to look at your life and see where the vulnerabilities lie and ask yourself what you would do to survive the financial hardships.
What would your partner or spouse say if he or she knew the terms of your current mortgage?
Sometimes family finances are controlled by just one partner, and the other partner doesn't know the details of things like what type of mortgage terms the couple has on their home or second home. Don't laugh, this is more common than most people think! Or maybe the other spouse knows what the current payments are, but has no idea the monthly payments on that risky mortgage could spike in the next few years. It's a good idea to reveal all, even though it might be difficult. Bringing the terms of your mortgage out into the open for discussion can force you and your spouse to take a hard look at your finances. Together, you can make informed decisions about your mortgage and your future.
Take These Steps
If the three questions outlined above give you pause when you consider your own situation, then you should shop around for another mortgage. Consider a less-risky loan, preferably a fixed-rate mortgage. This will give your finances some stability. Go to any mortgage or banking website and use their mortgage calculators to compare your current loan with a new, fixed-rate mortgage or other options.
Also, get your credit score. This is the figure that mortgage lendesr use to determine how much loan to give you. It's called your FICO score and anything under 620 means you are a subprime borrower. If your score is above 650, you're probably a prime, or less-risky borrower. This means you have the chance to get a new loan with better terms. If your FICO score is low, then do what you can to improve it. Pay all your bills on time and chip away at your existing credit card debt, if you have any. Don't apply for any new credit cards right now, and don't close any credit accounts, either. Having a credit history helps your score, so cancelling credit cards will eventually erase some of your history. Getting your credit score hiked up can take a couple of months, so be patient.
Once you've improved your credit score, start shopping around for a new loan. Make sure you understand everything about the new loan, and don't sign anything until you do. Not understanding the loan terms is how so many people got into trouble with the risky mortgages in the first place. Smart, well-educated people got mixed up because they didn't examine the loan carefully or didn't ask enough questions first before signing the papers. Remember, you don't have to take out the maximum amount that a lender offers you. Borrow only what you need, and consider carefully just how much house you need to be happy. Square footage isn't everything, but financial security sure is worth a lot.