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Surviving Your Subprime Loan
At first subprime loans seemed like a fantastic concept. These loans allowed people who would not have been able to purchase a house become home owners. This was a dream for those who just obtained their real estate license. Brokers and real estate salesperson were making great money. The problem though is that financially, many of these Americans could not and cannot afford the costs associated with home ownership and are now finding themselves in a major mortgage crisis. As today's economy is showing, rates are increasing, property values are decreasing, margins are shrinking, and regulatory pressures are mounting. An escalating foreclosure rate is evidence of the severity of the problem.
The common factor in many of the foreclosure statistics is that the loans were not designed to sustain the borrowers' financial success looking forward. In other words, subprime loans only focused on the short-term situation, not the long-term solution. Loans with low initial rates provided the borrower with a desirable house and affordable payments but only on a temporary basis. The higher adjusted rates have been the major factor for many of the delinquency, default, and foreclosure statistics.
As many of these Americans are now finding themselves at the end of their interest only period and begin making regular mortgage payments they find themselves in a conundrum. They really only have two options:
  1. Get a new mortgage
  2. Live with the current mortgage and make significant cuts to their lifestyle.
These are the only options if one wishes to maintain their financial health.
Getting a new mortgage
First and foremost, those looking for a new mortgage must be prepared and know the facts.
Know Your Credit, Equity, and Income
Credit (FICO score), equity, debt and income are the three primary factors used by all lenders to determine eligibility.
  • Know your FICO (credit) score and what it means.
    Request a free credit report. You can do this online through various credit report web sites. You must realize how the score affects your mortgage options: lower FICO = less loan options and a typically higher interest rate; higher FICO = more options and a typically lower rate. A 720 FICO score or higher usually has the best options.
  • Know your current mortgage pay-off amount.
    Find out the specific dollar amount needed to pay off your current mortgage. In most cases, the pay off balance is different from and higher than the mortgage balance. There may also be a penalty if you pay off early.
  • Know if there is sufficient value in your property.
    The peak of the real estate market in the US happened in about August 2006. After this date property values in most markets have come down. Understanding the current value of your property will determine the viability of refinancing.
    Realize today that you may no longer qualify for refinancing. During the mortgage boom (2002 - 2006), qualifying for a refinance was much easier because of heightened property values, the prevalence of 100% financing, and access to "stated income" loans. Most of these programs no longer exist which will limit your refinancing options. On top of that, any loan that exceeds 80% or 85% of the property value falls into a higher risk category and therefore results in higher mortgage pricing (increased interest rates or fees).
    In order to determine your property's current value, look at the sales of similar homes over the past 60 days. Based on the current property value and mortgage balance, you will have to make a very difficult decision and determine "Do I have enough to pay off the current mortgage and any margin?" If it is not possible to pay it off than it is best to simply reexamine your budget.
    It is a good idea to also speak to a realtor with a real estate license to see if they have some options.
  • Debt & Income Ratio - Personal Budget Analysis
    Know exactly where you stand. Pre-qualify yourself before you look for a mortgage. Typically, quantifiable debt to income ratios (DTI's) vary from 31 to 35%. Calculate your DTI by dividing your monthly mortgage payment by your monthly gross income. If your ratio is more, you probably cannot and should not refinance, and should look at modifying your budget and lifestyle.
Live with your current mortgage
Keep Your Mortgage Up-to-date
A mortgage foreclosure will dramatically affect your credit, and may remove options for future home purchases. Talk to your unsecured creditors (credit cards and personal loans) about options to reduce your payments to help you get through this period. It is also advisable to speak to a reputable credit counseling company. One thing to remember is that a bank doesn't want to repossess your home. They want you to succeed in life and enjoy your house just as much as you do. Speak to your loan manager. Maybe they will have some options to help with your payments.
Develop a "just the basics" spending plan.
Cut clothing, entertainment, restaurants, and everything else that is not absolutely necessary. You may also need to consider a second job. I recommend obtaining your real estate license and becoming a realtor. A last step is to identify things you may be able to sell that have value.
These will be difficult steps but will be necessary in order to retain your financial health.
In conclusion, subprime loans turned out to be exactly what they looked like... too good to be true. Many Americans are going to have to make very difficult decisions.
Posted by Tom Chambers on January 30, 2008
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