How to Deal With Higher Mortgage Payments When ARMs Wreak Havoc
As the housing market continues to cool, higher mortgage rates have upped the mortgage payments for homeowners who have adjustable rate loans, or ARMs, causing the number of mortgages in default to rise.
On CBS’ The Early Show yesterday, financial expert Ray Martin spelled out the problem, and offered advice to homeowners finding it harder and harder to make their mortgage payments:
The percentage of mortgages with delinquent payments has risen nationally to 2.33 percent, the highest level since 2003.
It’s expected that mortgage default, in which a borrower misses one or more payments on a loan, will increase when the economy weakens and job losses rise. Typically, job losses translate into a higher percentage of missed home loan payments. At this time, the percentage of home loans in default at 2.33 percent is closer to the historical average.
But this time is different: The economy continues to add jobs and defaults on home mortgage loans are still rising. According to reports from home loan counseling agencies across the nation, the main reason homeowners give for falling behind on payments is not a change in their lives, but that they are not able to make the increased payments on their ARMs.
Pick-A-Payment Mortgages
One form of home loans — the so-called Option ARM — is especially painful to home owners. Option ARMs allow the borrower to pick from four payment options, the lowest being an amount that is only a portion of the interest due and that does not include any principal.
The interest not paid gets added back to the mortgage each month, a process called negative amortization, and actually increases the amount owed. When the loan increases to 125 percent of the original amount borrowed, the loan is “re-cast” and full PITI payments are due, often resulting in “payment shock” — a dramatic increase in payments.
The industry estimates that interest-only mortgages and Option ARMs have soared in popularity, making up 0.05 percent of mortgages in 2003 but at least 12 percent of all loans through May 2006. In high-priced coastal areas, Option ARMs are estimated to make up 25-50 percent of all mortgages. According to Fitch Ratings, up to 80 percent of Option ARM borrowers make only the minimum payment.
A New Warning Over Option ARMs
The concern over this situation has recently prompted the Federal Reserve, working with a number of federal banking agencies, to issue the special publication, “Interest-Only Mortgage Payments and the Payment Option ARM — Are They For You?” It warns consumers and urges them to be realistic regarding whether they can handle the inevitable payment bumps these “nontraditional” mortgages dish out.
An Opportunity for Some
In some areas where rising home mortgage defaults are reported, about one-in-five of these homeowners lose their homes to foreclosure.
The number of properties in trouble continues to rise, with foreclosure listings at more than 120,000, pre-foreclosures at more than 255,000 and bankruptcy filings at more than 386,000.
For some, especially investors, increased delinquency rates create opportunities. Bolstered by the many home-flipping shows that dot the TV landscape, the increase in foreclosures has spawned increased interest in making money by scooping up homes at foreclosure auctions at 20-30 percent discounts from market value, then renovating and selling them at a higher price.
Options for Borrowers with Option ARMs
Most home buyers should never use an Option ARM, but if you have one, you need to know the risks and how to protect yourself. Here are a few tips:
Pick A Payment Wisely: As tempting as it may be, avoid paying the minimum monthly payment. At a minimum, pay all of the interest due. Also, read the terms of the mortgage carefully so that you understand when your mortgage will reach the dreaded negative amortization stage, and when your mortgage can be “re-cast,” which would result in a higher payment.
Call Before Payments Are Late: If you know you can’t make timely payments when your ARM payment increases, don’t wait until after you’ve missed a few payments to discuss it with your lender. Talk to the home mortgage company before things get out of control. Your lender is interested in keeping loans from going into foreclosure and may be able to work something out with you.
Refinance To a Fixed Rate Mortgage: For many with Option ARMs, it may be better to refinance to a fixed-rate mortgage in which the payment will be higher but never changes, rather than continuing with an Option ARM and dealing with the inevitable shock of a payment that is even higher.
But carefully check the current mortgage for additional fees that may apply during a prepayment period, which could be up to three percentage points of the mortgage amount. Also, there are closing costs to pay when refinancing a mortgage.
If you do refinance, ask your new lender about streamlined refinancing, in which the new lender can use the paperwork, appraisals and documents from your prior mortgage to reduce the closing fees.
Consider Mortgage Refinancing Alternatives: Some mortgage lenders, seeing their customers with ARMs leaving to other lenders who offer fixed rate mortgages, are offering alternatives such as loan modifications, in which the lender offers to change your current mortgage from an ARM to a fixed-rate loan for a fee of a few hundred dollars.
Cancel Unnecessary Fees: If you originally made a down payment of less than 20 percent, then you are probably paying Private Mortgage Insurance, or PMI, with every monthly payment. If you live in an area where home values have appreciated since your took out the mortgage loan, it may be worth looking into canceling the additional PMI.
If your home’s value is such that your current mortgage balance is only 80 percent or less of the value of the home, then you might qualify. Your lender may require you to get a new appraisal of your home, which may cost you a few hundred dollars, but that could save you a few hundred dollars a month by canceling the PMI.