What Led to the Mortgage Crisis?

Subprime Loans

A subprime loan is a loan that is offered to subprime borrowers who do not qualify for conventional loans usually because of credit issues.  Subprime borrowers have a higher rate of defaulting on the debt repayment and the interest rate on the loan is usually higher or the terms are such that it is impossible for the borrower to repay the loan. 

ARMS’s and Option ARM’S

What lead to the recent mortgage meltdown was a number of subprime loans adjustable interest rate loans (ARMS) being issued to borrowers who could not afford the mortgage payments when their interest rates reset. The interest rate on these loans are adjusted periodically, usually on a yearly basis. 

Option Arms are another type of loan that industry experts fear will lead to more foreclosures this year as those rates reset.  The rate adjusts in conformance with some money market indicator, such as the cost of one year Treasury notes.  If the cost of T-bills goes up a certain percentage, so does the interest rate for the next year. These loans are adjustable-rate mortgages that allow the borrower to choose from different payment plans each month. The borrower can make a standard mortgage payment (principal, interest, taxes, insurance or PITI) which will pay their loan off 15 years or 30 years. The borrower can choose to pay the interest charged the previous month only. The borrower can make a minimum payment that will not even cover the interest, which is known as a convenient option when money is tight, but this type of payment increase the total mortgage balance.

Typically option ARMS have teaser introductory interest rates as low as percent, but then those rates rise and continue to while the required monthly payment changes only once a year.   If the introductory interest rate starts at two percent, it can end up doubling, tripling and quadrupling. The borrower’s minimum payment rises at a maximum rate of 7.5 percent a year. The result is negative amortization.  The balance owed on the loan is steadily increasing.   

The Economy and Declining Home Prices 

The economy and declining home prices the last two years caught up with everyone involved and has now even affected homeowners with traditional mortgages.  According to statistics, almost one in 10 home mortgages is either delinquent or in foreclosure, and analysts estimate that at as many as six million families could lose their homes over the next three years in the absence of government action. So the government has stepped in with m

The last year or two homeowners because of a financial hardship such as a job loss, divorce or death or declining property values, were no longer able to make their mortgage payments and did not qualify to refinance because either they did not have enough equity in the properly or their credit was poor so they defaulted on their loan payments. In many cases the property value declined so they owed more on their mortgage than the property was worth. Hence, the record number of foreclosures appeared and short sale transactions have become the norm .

A number of these loans were made and are now being considered as predatory loan practices by the lenders.  Foreclosure defense attorneys have sprung up asserting defenses such as predatory loan practices in order to stop or delay the foreclosure process.  People who select option ARMs as their mortgage need to be fully aware of the math.  It is not uncommon for mortgage debt to rise at the rate of several hundred dollars per month while the home owner is making those smaller and easy monthly payments. After a certain point, somewhere around 110 percent of the loan’s initial amount, the lender will require payments be made on the principal as well as interest. easures to help homeowners with subprime mortgages and traditional mortgages negotiate with their lenders to avoid foreclosure. Many lenders have been working with subprime borrowers to help them obtain mortgage modifications. Now with the new $75 billion plan known as the Homeowner Affordability and Stability Plan, homeowners may be able to refinance and get better interest rates so that their mortgage payments are more affordable and they will not have to lose their homes to foreclosure.  Of course if a homeowner has no ability to repay their mortgage payments even at a reduced rate, then they may end up losing their home in the end.   

Homeowners Who are Seeking to Refinance 

The new plan available to borrowers who are current on their mortgages will allow them to refinance at lower rates even if the value of the home has fallen. Currently, if you are upside down, you are unable to refinance if you have less than 20% equity in your home. Under the new guidelines homeowners with debt that exceeds home value by 5% could be eligible to refinance with no prepayment penalties.  The catch is your loan must be owned or backed by Fannie Mae or Freddie Mac. The Administration estimates that this help up to 5 million homeowners to refinance and obtain lower interest rate mortgages. Borrowers will have to prove they have sufficient income to make their payments, but it is unclear as to what is meant by sufficient income right now.

Ineligible Homeowners

Homeowners whose property values have declined and put them upside down on the mortgage by more than 5% are ineligible. Those with jumbo mortgages are also ineligible. If you are not sure if you have a jumbo or conforming loan you can check with your servicer or lender. Until the past year, loan above $417,000 were considered jumbo mortgages, and Fannie Mae and Freddie Mac were not allowed to buy and guarantee them.

Mortgage Modifications for Borrowers in Default 

Homeowners in default or at risk of defaulting may qualify for mortgage modifications, which is a restructuring of their current loan by either adding a longer term or putting the defaulted amount at the back of the loan.  If you are upside down on your mortgage and have high debt to income ratios, you may be eligible for a loan modification.  If you qualify, your servicer or lender will reduce your monthly mortgage payments to 31% of your gross income. The payment would stay at that amount for a period of five years and then gradually revert back to the conforming loan rates in place at the time.  Most of the reduction would be from lowering interest rates, while some would be from principal reduction.  Borrowers would also receive incentive bonuses of up to $1,000 a year for five years for continuing to make their payments on time.  This plan should help borrowers with subprime loans.  The President estimates 3 to 4 million homeowners could benefit from the new modification rules and guidelines.

Eligibility Requirements.

Investors are not eligible.  All homes must be owner occupied. No loans will be modified unless it results in a net savings compared to the costs that are associated with foreclosing. Rates will not be lowered below 2%. Only conforming mortgages are eligible.

If you may need legal advice regarding mortgages, consult with a specialized Real Estate Lawyer in your area for a free case review.

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