How to Protect Your Mortgage From Default

If you’re a mortgage loan holder, you don’t need us to warn you about the dangers of the current market. Foreclosures and defaults are cropping up across the nation, especially for those in the subprime market.

With that in mind, consider these questions in order to stave off financial disaster:

• First, a set of old-fashioned financial-planning queries: Are you spending more than 28% of your pretax income on mortgage principal and interest payments, plus property taxes and homeowners insurance? Or do these four items, plus all your other debts, add up to more than 36% of your gross income?

Mortgage bankers used to deploy these benchmarks religiously. In their zest to issue new bad credit home loans, however, some have decided it’s fine if the figures are up into the 40s or 50s.

You don’t want to go up there for long. After taxes and a 401(k) deposit eat up 30 or 40 percentage points of your income, you’ll need money left over for milk and meat and the fridge going on the fritz. And if your mortgage payment is about to spike higher, you’ll be that much more vulnerable to unexpected calamities.

Then there’s the spouse test. Ask yourself what your significant other would think of the terms of the home mortgage if he or she only knew about it.

When Jeffrey Seymour of Triangle Wealth Management in Cary, N.C., sits down with new clients, he often finds that the husband handles the finances - and hasn’t told his wife that the monthly mortgage payment on, say, the beach house, could rise by four figures over the next several years.

The revelation isn’t always a happy one. But it can lead to productive conversations. “Frequently they’ll have different views on risk, and they might not even know it,” Mr. Seymour says.

Finally, imagine a confluence of nasty events hitting you all at once. Take, say, a young family in a fixed-rate, interest-only mortgage, where they pay nothing toward principal for years until the monthly payment resets to higher levels. The husband has a solid job, the wife is finishing training for a high-paying career (say, a doctor), and considering all of that, they’re comfortable with the higher bills ahead.

Several years later, the couple gets divorced, or she has quit the practice of medicine, or one child is ill - or perhaps a combination of such events. Suddenly, they can’t afford the new payment, they need another dwelling and the value of the house has dropped.

Then what? “Do you have sufficient reserves to ride it out?” asks Christopher Van Slyke of Capital Financial Advisors in La Jolla, Calif. “And if you tightened your belt without reserves, could you make it?”

All of this may seem overly risk-averse, but Mr. Van Slyke is merely prudent, not timid. In his own case, he says, back in 1999 when he bought his first house, he financed 100% of the $750,000 price tag. But one factor that gave him the confidence to do that was that he knew he would be willing to take in roommates if things really went south. (Everything went fine, and he now lives in a different, bigger house.)

If your own circumstances give you pause when faced with the questions above, it’s worth at least shopping for a fixed-rate mortgage that could give you some stability.

• Before you research rates, go to myfico.com to buy your credit score, which is the figure that most mortgage lenders consult when considering your creditworthiness.

A FICO score of between 620 and 650 or so is the rough dividing line between prime (good credit) and subprime (more risky) borrowers. Anything above 760 or so (out of 850) probably won’t give you a much better rate.

If you’re on the lower end, improving your score is especially important, because many mortgage lenders who service that market are tightening their standards or getting out of the business altogether.

To get your grade up, pay every bill on time and try to lower any outstanding credit-card debt. Don’t open a bunch of new credit-card accounts - but don’t close any either, because the length of your credit history factors into the score.

Once your credit is in shape (it could take as many as 60 days to see results), go shopping. When you find a loan you like, don’t sign anything until you understand everything. Incredibly, there are still plenty of smart people getting mixed up in home mortgage loans with terms and reset rates that they don’t understand.

Don’t be one of them.