Here's part two of my thoughts on the recent U.S. News series on the slowing real estate market. Today, we'll be covering the issue of what to do when you're cash strapped with a mortgage and it's soon to adjust upwards. Yikes!!!
Let me start by saying that there are proper guidelines for buying a house, and if you ignore them, you're putting your net worth in a whole lot of danger. But most people do ignore them, instead opting to stretch their finances as far as humanly possible to buy the largest house possible. And, unfortunately, many have financed their home with a ticking time-bomb mortgage that will be up for adjustment soon. The "adjustment" period will not be pleasant, that's for sure.
Want a real-life example? The U.S. News piece titled "Mortgage Roulette" details a couple who got into a bad mortgage like the ones noted above. Here's their story:
Melvin lacked the cash for a traditional 20 percent down payment. Nor did he have the income needed to qualify for the best rates on a conventional fixed-rate loan. So a mortgage broker steered him toward what's known as an 80-20 loan package: an interest-only mortgage totaling 80 percent of the new home's $257,000 price, combined with a home equity line of credit to cover the 20 percent down payment.
The mortgage's 5.65 percent rate is fixed for the first five years, keeping Melvin's monthly payments low. But the credit line's floating rate has since ticked up by more than 3 percentage points, increasing his tab by about $100 a month. And with the chance that his total monthly payments could eventually double, he wonders if he should bite the bullet and refinance now. (For Melvin, it's a monthly payment that could double to about $2,500 when it resets.)
Ouchy wa-wa!!!! (That's money-talk for it's really, really bad.) This is what I mean by a ticking time-bomb mortgage.
So this guy couldn't really afford the house, bought it anyway using a financially-questionable mortgage, and now he's paying for it -- and soon to pay even more. Unfortunately, he's not alone:
Over the next four years, about a quarter of all home mortgages will undergo a rate reset--almost certainly upward--on approximately $2 trillion in mortgage debt, according to estimates by the mortgage data firm LoanPerformance.
So, what should people do if they find themselves in this situation? Here's what U.S. News says:
"If your rate is due to adjust within the next year or so, then, yes, you should probably refinance," says mortgage banker and syndicated columnist Lou Barnes. But for most people with steady jobs, ample savings, and a mortgage that doesn't adjust for an additional four years or more, "there's no reason to panic and do something just out of fear."
To figure out whether to refinance, people with adjustable-rate mortgages need to assess their financial and personal stability. How much cash have you set aside? What are the chances you'll relocate in the next few years? How stable is your job? And, for that matter, how's your marriage? "Even though it may be a remote possibility, you've got to consider the worst-case scenario," says Barnes, the mortgage banker.
Remember all those people arguing with me a year or so ago about how interest-only, adjustable rate mortgages were a good idea, how they could be useful if done correctly, etc.? As I noted, yes, they COULD be used properly, but they usually aren't. Now people who got those mortgages (and there's a lot of them) -- many at the "advice" of "professional mortgage advisors" -- are having to deal with the financial consequences of this bad, self-serving advice. And it's going to get worse before it gets better. I just hope for their sakes that it doesn't get that much worse.
Amen, Amen, Amen... This country is looking for a rough ride ahead when it comes to the real estate market. It isn't just loans, but over pricing and other issues.
There are a lot of good people that are about to pay a hefty price.
Posted by: Scott | August 04, 2006 at 03:15 PM