Resetting mortgages put many in a corner

The Baltimore Sun

When Enej Dreca took out an adjustable-rate subprime mortgage in 2005, he knew the interest rate was likely to rise in two years.

But he wasn't prepared for how high it would go.

His initial 8 percent rate would have soared to 11 percent this year, raising his monthly mortgage payment by about $350.

"It was stressful because I am the only one working in the family, so we thought it was a big punch to our budget," said Dreca, who owns a remodeling business. "We were thinking about what kind of adjustments we were going to make."

In recent years many homebuyers eagerly bought into adjustable-rate mortgages, or ARMs, in which lenders offer low initial interest rates in exchange for the possibility of an increase, usually one to five years later.

Many of those loans' interest rates are now adjusting upward after the fixed period ended. Experts advise homeowners to know the details of their rate increases and prepare well ahead of time for a large increase in their mortgage payments.

"If you get hit with that notice that your payment is going to go up, and if you're not prepared for it, and if you don't have that wiggle room in the income you bring in every month, that's very scary," said Janet Zuppa, a loan purchase administrator.

Let the house go?

"You have to make a decision - do I let my house go back [through foreclosure], and what do I do with my debt?"

In a perfect world, you should be ready for the rate adjustment, assuming you clearly understood the terms of your mortgage.

But not everyone's that informed, given the complexity and how overwhelmed homebuyers feel at the closing table.

"People are very focused on their monthly payment, rather than absorbing the other critical details of their loan, such as what type of loan is it, will the rate adjust later and by how much," said Greg McBride, senior financial analyst at Bankrate.com.

Those who do know they have an adjustable-rate mortgage may not keep up with economic changes that affect it.

"The majority of people who have ARMs aren't savvy enough to watch the market to see what's going on," Zuppa said. "The majority of people are not planning ahead and not seeing into the future on what to do if that rate changes."

Lenders are required to give you a 30-day notice that your rate is scheduled to reset.

There's hope of surviving a rate adjustment, but you really have to take serious action.

"You have to take a top-to-bottom look at your entire household budget," McBride said. "Your mortgage payment is the biggest component of your budget, and if it's going to increase a substantial amount, that money will have to come from someplace else."

First, look for places where you can cut expenses so you have extra money for the higher mortgage payment.

"This isn't going to be a gap that you're going to make up by not supersizing lunch every day," McBride said. "This is a gap that's going to be made up by getting a second job, working overtime, selling a second car and aggressively cutting household expenses."

Refinancing to a fixed-rate loan is an option, but it may not be easy. For one thing, the new interest rate is still likely to be higher than the one you have now.

Also, loans are harder to come by now. Some lenders who were handing out mortgages to anyone who came in the door have gone out of business. The others have tightened up their standards.

Credit sours

Your credit may have soured since you got your ARM, your income may have shrunk or your home's value may have fallen.

And if you didn't put much money down when you got your ARM, your chances of getting new loan terms are worse.

"Refinancing may not be an option, if you've got a 95 percent or 100 percent loan to begin with, because lenders have tightened up," said Steve Fagan, vice president of mortgage lending at Texans Credit Union.

If you have a subprime loan - which is made to consumers with poor credit - the hurdles are even higher.

"We can hope that they have improved their credit and can refinance into a more standard rate," Fagan said.

Loan penalties

Before refinancing, subprime borrowers also need to ask their lender whether there's a prepayment penalty on their loan.

"Lenders set prepayment penalties for subprime loans to compensate for the risk," said Craig Jarrell, president of Dallas region of Pulaski Mortgage Co. "Lenders typically want a guaranteed income stream of at least 24 months to justify the risk."

The costs of refinancing may not be worth it for some homeowners.

"It's not always a good idea to refinance for a lot of people just because of the closing costs and fees that go into the balance," said Reid Remington, director of housing and technology at Consumer Credit Counseling Service of North Central Texas.

"We've had people where we've seen them doing a refinance, and it ended up adding an extra $10,000 to the balance of the loan. Most of it is closing costs and fees that are rolled over into the loan."

The biggest determining factor is how long you plan to stay in the home, to make sure you can recoup your refinancing costs.

But it's not all doom and gloom. Shop around for a refinancing and see what happens.

When Dreca approached his lender, the bank said he would have to pay closing costs to refinance into a fixed-rate mortgage.

"I was not happy, so I went to Chase Mortgage," Dreca said.

He had improved his credit score to the point where he was able to upgrade to a prime mortgage with a 5.75 percent fixed rate through Chase's program for low- and moderate-income homebuyers. The result: His mortgage payment is actually almost $100 less a month than it was.

'Try to pay my bills'

"I try to pay my bills on time. I work for my money, and I try to raise my family," said Dreca, the father of a 3-year-old and an 11-year-old. "That's all I do."

If you absolutely won't be able to afford your new payment, contact your lender immediately. The company might be able to work out several options with you.

That may mean granting "forbearance," in which the lender agrees to temporarily reduce or suspend your mortgage payments.

The lender also may extend the term of your loan, which would reduce your mortgage payments to a more affordable level each month but give you many more months to pay them.

Personal experience

Zuppa knows about rate adjustments, not just from her job at Texans Credit Union but also because she and her husband recently had to deal with one.

They had been making extra payments on their mortgage, which helped them to refinance to a fixed-rate mortgage because they had built up enough equity.

Without refinancing, their mortgage payment would have gone up by about $400 a month, to $1,200.

As it is, with the refinancing, the payment is $100 higher, or $900, because of the higher interest rate. And she and her husband find themselves just starting out again on a 30-year loan.

The Zuppas also took out a consolidation loan on some other debt, which freed some money for their new mortgage.

"When I first did the ARM, rates were so low, and they were so low for so many years," Zuppa said. The rate reset "was a wake-up call that we needed to get our p's and q's in a row."

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