Ballooning credit card debt among American consumers is stoking demand for a new -- and potentially risky -- home mortgage product: a loan that allows you to borrow up to 125 percent of what it's worth.
Lenders across the country are scrambling to offer what some industry analysts believe will be the hottest mortgage concept of 1997.
Wall Street mortgage market analyst Jonathan Lieberman, a senior researcher for Moody's Investor Services, predicts that lenders will make more than $7 billion worth of no-equity and negative-equity home mortgages in 1997, up from just $200 million in 1995 and $3 billion in 1996.
No-equity lending appears to turn long-standing rules of real estate mortgage underwriting upside down.
Whereas banks historically have insisted on borrowers having some stake in their property -- a down payment of 10 percent to 20 percent for a new loan, or an equity position of 10 percent or more for a refinancing -- negative-equity lending requires no stake whatsoever.
In fact, according to a new study authored by Lieberman, most lenders offering negative-equity loans don't even bother getting a formal appraisal of loan applicants' homes.
They settle instead for what's known in the trade as a "drive-by" -- a quick look at the home and the neighborhood -- to gauge its rough market value.
The typical no-equity mortgage runs anywhere from $10,000 to $100,000 and carries a note rate of 13 percent to 14 percent.
The typical borrowers, according to Lieberman, are an individual or couple with "basically good income and credit" -- no defaults or foreclosures -- but who have run up heavy credit card and other consumer debt during the past year or two.
"Their credit cards are eating them alive" at interest rates of 19 percent to 21 percent or higher, Lieberman said.
Fifty percent to 60 percent of their monthly income has to go to payments on their cards and their existing mortgage.
What options do debt-drenched homeowners have?
The answer offered by the growing ranks of no-equity lenders: Convert your credit card debts into mortgage debt -- even if the resulting total mortgage balance exceeds the resale value of your real estate by a substantial amount.
The rate on such a mortgage is lower than what you pay on your cards, and the 15- to 20-year payback terms are much longer -- thereby reducing your monthly payments.
Plus, at least for principal balances of up to 100 percent of your home's value, your interest payments may be deductible under federal tax law. All consumer debt interest payments, by contrast, are nondeductible.
Most negative-equity financings take the following basic form, according to Lieberman's research: The borrower's existing first mortgage remains in place. A new, second mortgage is added on top of the first loan to take the homeowner's housing-related debt beyond the value of the property.
Say, for example, you own a home worth $100,000 and you've got a first mortgage or deed of trust of $85,000 at 9 percent. But you've also racked up $40,000 in combined charge card, furniture store and auto debts. You've never missed a mortgage payment, but you're getting stretched to the breaking point by the 18 percent average interest rate on your consumer debts.
The no-equity remedy: You apply for a $40,000, 125 percent loan-to-value financing deal at 13 1/2 percent for 20 years. The loan proceeds allow you to pay off all your card balances and the auto loan. And, thanks to the 20-year term and the 13 1/2 percent rate, your monthly payments on the $40,000 are more than $500 lower than what you were paying before.
What are the pros and cons of a negative-equity loan like this? Purely on a cash-flow basis, taking your mortgage debt to 125 percent of your home's value may give you the breathing room you need. You can consolidate your nondeductible, high-rate debt and convert it into lower-rate, partially deductible mortgage debt.
But the potential downsides can't be ignored. For starters, if a negative-equity loan doesn't change your underlying behavioral problem -- over-consumption of goods and services via credit cards -- then eliminating your home equity stake may increase your probability of filing for bankruptcy.
Second, in an economic downturn, people with little or no equity end up in foreclosure far more frequently than people with solid equity stakes.
Finally, get competent tax advice.
The Internal Revenue Service reportedly is concerned that some borrowers believe all home mortgage interest on loans below $1 million is tax-deductible. Not so.
You can never deduct interest on any portion of your mortgage debt that exceeds the fair market value of your house.
Pub Date: 12/29/96