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The New Climate for Mortgage Borrowers
You've probably read or heard about recent problems in the housing market — even if you haven't directly experienced declining home values, higher interest rates on mortgages or more stringent lending standards. But what does it all mean for you, especially if you're thinking about buying a new home or refinancing an existing loan?
FDIC Consumer News wants you to know that while some mortgages may be tougher to get than in the past, you shouldn't be discouraged — many good loan programs are still available to homeowners. The key is to be proactive — to understand your options and to put yourself in the best position to take advantage of them.
And, if you're facing the prospect of losing your home to foreclosure because of rising payments, you need to contact your lender or loan servicer as soon as possible to work out a reasonable solution. A loan servicer is a company that collects payments and performs other work for lenders, even including negotiating new payment plans with borrowers who are late or delinquent on their loan payments. "No one gains from foreclosure — not the lender nor, least of all, the homeowner," said FDIC Chairman Sheila C. Bair.
We've previously published tips to help mortgage borrowers, but here is a roundup of our latest suggestions. These ideas are for all homeowners because anyone can be affected by tighter credit standards or find themselves having trouble making their mortgage payments due to a job loss, health problems or other misfortune.
First, a few words about how conditions have changed and why. From about 2000 through 2005, interest rates were low and home values soared in many parts of the country. Many lenders met the strong demand for mortgages by promoting nontraditional mortgages (NTMs), which are characterized by low monthly payments in the early years in exchange for the deferred repayment of principal and/or interest. In addition, lenders offered "hybrid" adjustable-rate mortgages (ARMs), which have a low fixed-interest rate for the first two or three years, after which the interest rate periodically adjusts and mortgage payments generally increase.
Although NTMs (see examples) and hybrid ARMs can be appropriate for some borrowers, such as people who are likely to have increasing income or to move in a few years, for many other consumers these loans can result in unaffordable monthly payments as the deferred principal becomes due and higher interest rates apply.
A large number of borrowers used NTMs or hybrid ARMs to buy houses they otherwise could not afford. It now appears that many of them may not have fully understood the risks of these products, and lenders did not adequately evaluate their ability to make higher payments over the life of the loan. Some lenders also provided NTMs and hybrid ARMs to "subprime" borrowers — individuals with damaged or limited credit histories — on the assumption that real estate prices would continue to rise and would protect the lenders if the borrowers defaulted on the loans.
Starting in 2006, however, home values began to flatten or even fall. As interest rates on NTMs and hybrid ARMs reset, borrowers faced significantly higher and even unaffordable monthly payments. Borrowers who had planned to refinance to obtain lower payments found it difficult due to the declining housing market. Many people whose loans have reset, particularly those in the subprime market, have already missed payments, and that puts them at risk of losing their homes.
Now, lenders have tightened their standards for all borrowers. In general, they want to lend to applicants with a good credit record, the ability to make a reasonable downpayment, and fully-documented income to repay the loan. Lenders also are trying to better match borrowers with loans they can afford for the next 15 or 30 years, not just for the short term. So, how can mortgage borrowers find a loan that works for them?
If You're Looking for a New Mortgage or to Refinance
Try to raise your credit score in the months before you apply for a mortgage. Lenders look at a person's credit score, a numerical summary of a person's credit record, when deciding on loan applications. By aiming for the best possible score, you may be able to obtain a lower-cost loan and save hundreds each year in interest.
Protect your existing credit score by making all of your credit card and other bill payments on time. Beyond that, there are some quick things you can do to try to boost your credit score. One is to pay off much or all of what you owe on credit cards. "But don't close any credit card accounts and don't open any new ones before you get a mortgage, because either action could negatively affect your credit score," added Mira Marshall, an FDIC Senior Policy Analyst.
Also, review your credit reports for incomplete or erroneous information and get it corrected. By federal law, you are entitled to one free copy of your credit report every year from each of the three nationwide credit bureaus. Go to www.AnnualCreditReport.com or call toll-free 1-877-322-8228 to order free credit reports or for more information. For more suggestions on improving your profile, start at the Federal Trade Commission's Web site about credit reports and credit scoring at www.ftc.gov/bcp/menus/consumer/credit/reports.shtm.
If you're thinking about buying a new house, consider modifying your strategy. Think about making a larger downpayment on a home if you can afford it and if doing so will help you qualify for a loan or significantly lower the cost of a mortgage. And if you realize that a home purchase doesn't make financial sense at this time, consider waiting or looking at less expensive properties.
Contact several lenders and negotiate the best deal. Let them know you are comparison shopping. You may be able to negotiate the interest rate, closing costs or other terms, which could save you thousands of dollars.
Include your current bank and other local lenders in your search for the best mortgage. Recent studies show that financial institutions are more likely to make lower-cost home loans on properties in communities where they have branches. However, you can also take advantage of the Internet to research mortgage products, comparison shop among hundreds of lenders, and apply for a loan from those same lenders. But remember that con artists operate on the Internet, too, so for guidance on whether a bank is legitimate, call the FDIC at 1-877-275-3342 or use Bank Find, our online directory of insured institutions, at www2.fdic.gov/idasp/main_bankfind.asp.
Compare fixed-rate and adjustable-rate loans, even if ARMs carry a lower initial interest rate. With a fixed-rate mortgage, you pay the lender the same, fixed interest rate over the life of the loan, which usually will be 30 years but could be 15 or 20 years. With an adjustable-rate loan, your interest rate may be fixed for a certain time period but later will periodically rise or fall based on a market index. Although early payments at "teaser rates" may be lower with an ARM, the interest costs later on can go up significantly. "Frequently, the fixed-rate loan is cheaper and safer in the long run," said Janet Kincaid, FDIC Senior Consumer Affairs Officer.
Also carefully evaluate your ability to make payments throughout the life of a loan. "The mortgage loan originator should conduct a realistic assessment of your ability to repay, especially with an ARM, including the highest possible payment under the terms of the loan," said Victoria Pawelski, an FDIC Policy Analyst. "An unrealistic assessment based on a low, introductory payment can lead to payment shock and, for some people, a very costly foreclosure."
Start by asking for a side-by-side comparison of what you would pay each month with both fixed- and adjustable-rate mortgages and assuming that the ARM's interest rates will rise to their maximum levels. You'll most likely see that after, say, three years, the ARM could start costing more than the fixed-rate option, and eventually could be far more expensive.
Real estate taxes and insurance can add significantly to your monthly payments, and they are likely to rise in the future, so also include those costs in your review. (Even though a lender may not require escrow payments for taxes and insurance as part of your mortgage, it's important to factor those costs into your comparison.) Include any fees you would owe the lender and other service providers. Also find out if there will be prepayment penalties for paying off the loan early, because these can be very costly if you want to refinance or sell your home.
If you decide to go with an ARM, one way to protect against rising interest rates in the future is to add a "conversion option" that would allow you to switch to a fixed-rate mortgage in the future, for a set fee.
Be wary of a mortgage with payments that can increase substantially. "In the worst cases, people lose their homes when they take on mortgages they can't afford," said Sandra Thompson, Director of the FDIC's Division of Supervision and Consumer Protection.
Take the time to document your sources of income as part of your mortgage application. Some lenders offer loans requiring little or no documentation of income, assets and debts — they instead rely on a personal statement of the applicant's financial resources. "These loans may be faster and more convenient, but they also may be more expensive," said FDIC attorney Richard Foley. "You should always ask for the opportunity to document your financial resources because it could mean a lower interest rate or other cost savings."
Protect against unfair and deceptive sales practices by working with a loan originator you know or who comes recommended by someone you trust. "Scrutinize any fee you're being asked to pay a lender, broker or any other service provider," warned Pawelski. "And don't assume that every loan officer or mortgage broker will act solely in your best interest."
At or near the top of the danger list are "predatory" home loans, which are expensive offers involving false statements or misleading sales tactics, usually to people in financial trouble and without regard for their ability to repay. Another questionable and potentially costly practice involves situations in which a lender gives extra compensation to employees or outside brokers for steering a borrower to a higher-priced mortgage, while claiming to be offering the best possible interest rate. There also have been instances of aggressive or misleading advertising intended to lure consumers into inappropriate adjustable-rate mortgages by, say, using the word "fixed" when the interest rate and payment could actually change during the life of the loan.
To find out if a company or sales representative has been the subject of consumer complaints, start by contacting your state government's consumer protection or Attorney General's office, which will be listed in your phone book or other directories. That state office also may be able to guide you to another state or federal government agency for additional information. (For a warning about frauds involving home loans and credit repair, see Beware of Mortgage Scams.)
If You Can't Make Your Mortgage Payment
Ask your lender or loan servicer about restructuring or refinancing your mortgage as soon as possible. Remember that if you miss payments and default on a mortgage, you could lose your home. The lender has the right to foreclose — to sell your home to raise money to pay off your debts. You could owe the lender more money if the home sale doesn't cover your debt. You also could severely damage your credit record, which would make it more difficult to borrow money or get a job or insurance in the future.
Contact your lender or loan servicer as soon as you think you may not be able to make your loan payment and let the servicer know you are serious about addressing your debt problems and staying in your home. "The lender or servicer may be more willing to work with you on a solution if you show them that you are acting in good faith to improve your debt situation and address other problems," said Donna Gambrell, Deputy Director of the FDIC's Division of Supervision and Consumer Protection.
Also, don't assume that your lender wants to take your home. For cost and other reasons, most lenders prefer to avoid foreclosing on homes and selling the properties. In addition, federal and state banking regulators, including the FDIC, have encouraged lenders and mortgage servicers to contact borrowers directly, assess their ability to repay, and pursue appropriate strategies to help creditworthy consumers avoid defaulting on a loan. These strategies may include modifying loan terms (perhaps by lowering the interest rate or extending the repayment period) and converting ARMs into fixed-rate loans. "Institutions are encouraged to work toward long-term sustainable and affordable payment obligations," said FDIC Chairman Bair, who added, "Clearly, fixed-rate obligations provide the best opportunity for long-term stability."
So if you get a call or letter from your lender or servicer regarding the upcoming reset of your loan, be sure to respond.
Before contacting your lender, consider getting help from a housing counselor. These are public and private organizations that, typically for no charge or a small fee, can provide advice and assistance on everything from buying a home to dealing with debt problems. The latter includes help contacting and negotiating with lenders.
Be aware, however, that the FDIC and other government agencies have warned homeowners about costly credit-repair and mortgage-rescue scams (see Beware of Mortgage Scams). "For help working out a mortgage problem without paying significant fees and without fear of fraud, talking to a trained and certified foreclosure or housing counselor is a good choice," said Lee Bowman, National Coordinator of Community Affairs at the FDIC. To find a reputable counselor in your area, contact the U.S. Department of Housing and Urban Development or the Homeownership Preservation Foundation (see For More Help or Information on Home Loans).
Be proactive in researching and exercising your consumer rights. Start by reviewing your mortgage contract and other handouts and mailings from your lender. Solutions to your problems frequently can be found there, such as information about special programs the lender offers to help borrowers. Also check the Internet and other resources for your rights under state and federal housing laws. For example, if your mortgage is insured by the Federal Housing Administration (FHA), you may be eligible for special loan-modification programs and other assistance.
As a last resort, consider selling your home. If the sales price is high enough to pay off your mortgage, this will prevent the lender from foreclosing and will limit further damage to your credit record. But if the home sale won't cover your debt, ask your mortgage lender or servicer about your options. Having a housing counselor or other experienced party negotiate on your behalf also may be helpful.
Last Updated 11/08/2007