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Mortgage Crisis



The recent mortgage crisis is attributed to lenders who made risky adjustable rate mortgages and buyers who stretched their financing capability to purchase homes above their means.  Truth is, the problem has now spread far beyond risky loans and is now wreaking havoc on financially responsible home owners.  Home prices have decreased for the first time in many years.   This has resulted in recent buyers living in houses that have loans far exceeding their current market value...continued below

When the housing bubble began in the mid-90's, homes were appreciating in price so quickly in some locations buyers were seeing a return on their investment if they sold in as little as two years.  As the average price climbed month after month, year after year, ARM's again became popular but for a different reason.  Families were buying at the top of their price range.  By applying for adjusting loans, they were able to buy more house for the same payment.  The result was homeowners who were stretching to afford the low introductory rate of interest and many unable to qualify for fixed rate loans that would cause the payment to increase.

These loans appear to have some safeguards for consumers and in a reasonable market atmosphere that holds true.  They are fixed at a very low rate for anywhere from the first year to as long as five years and then adjust every two years, or yearly, or in some cases every six months.  The adjustments may be based on the one-year Treasury Bill or LIBOR) and do contain a cap limiting the percent of increase allowed for each adjustment.

One of the most critical aspects to know about your ARM is whether you have a pre-payment penalty.  For many years, lenders did not charge a fee for those who paid off their loans early (by selling their home) but it's now estimated that more than 80% of adjustable loans contain a hefty pre-payment penalty.  This forces borrowers to pay thousands of dollars in penalties if they refinance during the early years of the loan.

Though some economists warned of the dangers, the popularity of these specially structured mortgages soared though fixed rate loans were were the lowest seen in years.  New buyers wanted bigger and better homes and saw no reason they shouldn't have them.  After all, they reasoned, real estate values always increase - right?

The person who could qualify for a 5.75% fixed rate on a 30 year fixed rate mortgage on a $150,000 property learned he could also qualify to buy a $200,000 home by taking an adjustable loan with interest that began at 3%.  For many buyers, it was a no-brainer.  Assuming interest rates would not rise, assuming home values continued to rise rapidly, assuming their own income would be as good or better in future years - buyers assumed they were safe.

The harsh reality is this:

A fixed rate loan at 5.75% on a $150,000 will have a payment (P&I) of about $875 each month for the full term of the loan.
An A.R.M. with an initial rate of 3% for a $200,000 home will require a payment of "only" $843 per month....to start.
That same ARM after just two adjustment periods could require, at 7%, a monthly payment of $1330

Most lenders do have a cap that limits how high such a loan can go, but the caps are often high themselves.  Should interest rates rise in the next year or two as expected, it's possible that same home purchased for $200,000 and $843 a month could cost $1700 a month or even more.  For a family on a budget this could break their financial back.

Reality hit the fan when many of these risky loans reached their first adjustment period.  The economy was slowing, layoffs were common, jobs hard to find, interest rates had risen somewhat - and the refinancing option was difficult as mortgage money had become tight and loan requirements had been raised.

 True, some of these loans were high risk and made to those who had questionable credit or an inability to pay any more than the first monthly amount.  Those were the first to go into foreclosure but they have been followed by thousands of homes purchased by well meaning consumers who couldn't keep up with the rapid downward turn in the market.