Up In ARMs About Your Mortgage?

Tuesday , September 18, 2007

Gail Buckner, CFP

Dear Gail,

We were shocked to learn that our mortgage is going up nearly $500 a month. We knew that buying this house a couple of years ago would stretch our finances to the limit, but we really wanted our kids to attend this school district so we decided to bite the bullet and keep to a very strict budget in order to make this work.

We both have jobs, but there’s no way we can come up with another $500. And home prices have really come down since we bought our house, so if we have to sell, we’d probably take a loss.

I’m just sick over this. I heard that President Bush has announced a program to help people like us. What can you tell us?

Thanks,
Sheila

Dear Sheila,

It sounds as if you’ve got an adjustable rate mortgage about to be re-set at a higher interest rate. Several of the White House initiatives are aimed at helping homeowners in your situation keep their homes.

One initiative would give the Federal Housing Administration (FHA) greater flexibility to adjust down payments and interest rates. For the first time, borrowers with FHA-backed mortgages would have the opportunity to re-finance and potentially reduce their payments.

Waiting on Congress

However, I’m not sure anything will be done soon enough to help your situation. As you probably know, to a large extent the president’s hands are tied because, while he can make recommendations , it’s up to Congress to make the changes happen by passing new laws.

Although the House of Representatives overwhelmingly passed Bush’s “FHA Modernization” more than a year ago, the bill was loaded down with so many other “add-ons” (read: spending for unrelated special projects in various Congressional districts) that it was never signed into law.

When "Loss" = "Income"

The president is also asking Congress to temporarily change the tax code to provide relief to homeowners forced to sell homes at a loss — due to the fact that real estate values have gone down, even though their mortgage payments have gone up .

As the law stands today, if a lender cancels a debt you owe for less than the outstanding loan balance, the forgiven amount is considered “income.” Even though the borrower doesn’t receive any money, he/she still has to pay income tax on this amount.

For instance, let’s say you paid $200,000 for your house and have a loan for $180,000. If you live in one of the areas where the decline in residential real estate has been especially severe, similar homes in your area might now be selling for $160,000.

Assume that in order to avoid foreclosure, your lender agrees to release you of your mortgage for less than the current balance of $178,000. You sell the home, netting $158,000, which goes straight to your lender.

That additional $20,000 you owed the lender has been “forgiven,” and under the “cancellation of indebtedness” provision, this cancelled debt is now considered income. So when you file your income tax return next year, you would have to declare this $20,000 and, naturally, pay income tax on it .

Congress members have introduced several bills that would temporarily protect individuals from owing income tax on cancelled mortgage debt. Because President Bush also supports this idea, there’s a good chance legislation will eventually be enacted.

RE-financing Fairness

Over the coming months the Treasury Department will be reaching out to the FHA and private lenders, as well as community-based organizations such as NeighborWorks ( www.nw.org ), a national nonprofit created by Congress to provide financial and hands-on support for community revitalization projects.

According to the White House, the goal of the collaboration is “to expand mortgage financing options, identify homeowners before they face hardships, help them understand their financing options, and allow them to find a mortgage that works for them.”

Federal banking regulators are also considering ways to strengthen the disclosure requirements that lenders must provide to borrowers. One problem here is that in recent years, more and more mortgages are issued by private lenders, (Countrywide Mortgage, for instance) and the laws that govern banks and saving and loans do not cover private firms.

Deciphering Loan Documents

As you unfortunately discovered, mortgage documents are dauntingly complex. They are filled with terminology laced with legal and financial jargon that is difficult for the average person to understand. To combat this, there are also initiatives that would require clearer language and better explanations in loan documents so that borrowers fully understand the consequences of what they’re getting into.

The fact of the matter is: While perhaps the vast majority of mortgage brokers are honest, well-meaning individuals, we’re only now beginning to learn how many crooks were also operating during the recent housing boom. Investigations are underway at both federal and state levels, especially in formerly “hot” mortgage markets such as California , Florida , Nevada and Colorado.

Megan Burns, a former bank loan officer, points out that there’s an inherent conflict of interest: Mortgage brokers get paid based on the number of loans they write. This means officers have an incentive to approve borderline borrowers for larger loans than they might realistically be able to afford and to omit inconvenient details, such as the fact that the interest rate could rise significantly.

“People rely on loan officers” to explain the terms of their mortgage agreement,” says Burns. “But how can you when their income depends on them closing a loan?”

Sure, all of the details are disclosed in the obtusely-worded, 30+ page, loan document and may be explained verbally at the closing, but by then she says, “people feel pressured to sign because they could lose the house.”

Did I Hear Someone Say "Fraud"?

“Toxic mortgages,” that’s what Randy Johnson, a 27-year veteran of the mortgage business, calls these loans. From his location in Southern California , Johnson has seen some of the most egregious cases of mortgage brokers approving any loan they can just to make a buck.

“They put people in a $1,000/month mortgage with re-set characteristics that increase it down the road to $2,000 and don’t help borrowers understand that. It’s a prescription for disaster.”

Moreover, mortgage brokers receive a bigger payout based on the size of the loan and the terms. Johnson alleges that even “A-rated” borrowers who could have qualified for “a 30-year fixed at 6 percent” were sold subprime loans, the kind that “start at 6 percent for 2-3 years, then jump to 9 percent and bite you in the butt down the road.”

The sole reason, according to Johnson, is that mortgage brokers “made more than twice as much money for making a subprime loan than an A-paper loan.” He thinks the government “ought to devote a lot of energy to help people who have taken a great leap; to get good citizens to stay in their homes.”

He says the proposals to temporarily bail out these borrowers will “give people breathing room, allowing them to build up some equity.”

Borrowing Smarts

Johnson has written books to try and educate consumers about being smarter when shopping for a mortgage.

Burns, who got “frustrated” with the mortgage business because she refused to adopt the deceptive tactics of many of her competitors, quit to launch a Web site: www.TheOfferAngel.com .

According to Burns, “most of the site is free for consumers.” After you’ve received a loan proposal, you can go to the site and set up an account based on your email address. Don’t worry, you’re not required to provide any sensitive information such as Social Security numbers or income.

The site then e-mails a questionnaire to your loan officer or mortgage broker. “We ask them more than what’s required to be disclosed by federal law,” says Burns. “It’s everything borrowers should know, but aren’t being told.” When the questionnaire comes back, you’ll know, for instance, whether there is a pre-payment penalty, if your interest rate can increase and whether it’s capped at a certain amount. In addition, there are clear explanations of what the various terms mean.

By submitting a questionnaire for several different loan proposals, you can do an “apples-to-apples” comparison. You may find out that the loan with the lowest interest rate isn’t such a good deal, after all.

Don't Delay

In your case, Sheila, if you want to remain in this house, your best option is to re-finance your existing loan (hopefully, it doesn’t have a pre-payment penalty). Start by contacting your mortgage company as soon as possible and explain your situation. They might be willing to give you a new loan with more manageable terms.

But don’t stop there. You’ll also want to get at least one or two re-financing proposals from others lenders. Be sure to read the fine print! There are lots of Web sites that explain what the jargon means.

Hope this helps,
Gail

If you have a question for Gail Buckner and the Your $ Matters column, send them to: yourmoneymatters@gmail.com , along with your name and phone number.