With the housing market cooling down, people are starting to use a bit more common sense regarding their real estate financing choices. In particular, they are moving away from evil house loans and becoming a bit more financially prudent as the market changes.
This article from MSNBC discusses this trend and says that exotic mortgages are losing their allure. Here's why:
Now these cheap mortgages that fueled the real-estate boom are beginning to hurt the homeowners they once helped. Higher interest rates and the end of honeymoon periods for too-good-to-be-true teaser rates are increasingly causing payment shock for borrowers.
Many of these mortgages carry negative amortization features that permit borrowers to pile on additional debt beyond their original balance, and make minimal payments for the first several years. Once the initial period is over, however, payments could shoot up by 100 percent or more as the loan resets.
Other programs allow interest-only payments with no reduction in the original loan balance until the reset point. Then payments can jump by 50 percent or more in order to amortize the debt balance over a compressed number of years.
Does anyone remember the debate we had here a few months ago about this sort of mortgage? Remember how I said way too many people were taking advantage of them? And I made this comment:
My contention is that way, way, way, way, way, way more people are getting these loans than should be getting them and they're setting themselves up for a big fall. So, for the vast, overwhelming majority of people out there, this type of loan is not a good idea.
Others countered that they had this sort of loan, they had "made" (on paper) a ton of money on their house, that the loans were fine, yada, yada, yada. Well, they don't seem so fine now, do they?
My purpose here isn't to say "I told you so" or to hold myself out as some sort of great financial visionary that knows what's going to happen in the future. Also, I'm not sure that this problems described above are impacting that many people yet (you know how the media likes to blow things out of proportion). But I do want to again warn people to the dangers of having an evil mortgage and suggest that they avoid them at all costs. Here's one example of how bad these loans can be:
The letters contain hypothetical examples of what lay ahead. One is a California homeowner making only minimum payments on a $402,000 loan. The current full interest rate on the loan is 7.6 percent, but the borrower has been paying just $1,348.47, far less than what's needed to fully amortize the mortgage over its 30-year term. If the loan reset at today's rates, the full payment required would be $2,887.50 — more than double what the homeowner is currently paying.
The bottom line is that there is a reasonable, financially solid way to buy a house and if you follow it you should be fine almost no matter what the real estate environment is like. On the other hand, if you stretch yourself to the breaking point to buy a house you really can't afford, you will be the one broken when financial problems show up (which they almost always seem to do).
So, what should you do if you currently have one of these loans? Here are some suggestions:
Countrywide does offer advice to customers who want to prepare for resets in the coming year: They should either switch from the minimum and move to either a 15-year or 30-year standard amortization plan, switch to an interest-only option if full payments are not feasible to fend off still-higher principal debt balances, or explore alternative refinancing options sooner than later.
Greg McBride, a senior financial analyst at Bankrate.com advises exotic-loan holders to consider where they’ll be a year before their rate changes. “If you’re thinking that you’ll stay in your house longer than the four of five years you originally expected to, it’s time to refinance for a more appropriate loan.”
Long-term dwellers who started out with an exotic interest-only or pay-option ARM should take a look at fixed-rate mortgages, which are now at four-month lows, he said. “You’ll see a big payment increase but at least you’ll be certain that the payment will not change.”
Another option is to downsize to a more affordable home, especially if the current home was purchased three to four years ago. “You’re sitting on a nice chunk of equity that can give you some latitude to avoid payment shock,” said McBride.
In summary: Get out of a bad mortgage as soon as you can and get into a more solid, traditional mortgage.
For more of my thoughts on real estate and housing, see Best of Free Money Finance: Real Estate Posts.
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