Financial Literacy 2007 - Mortgages
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Exotic mortgage holders face tougher conditions

Refinancing a mortgage, all of a sudden, isn't such an easy thing to do. And that's troubling news for some homeowners who bought during the last two or three years using interest-only mortgages, payment-option plans or adjustable-rate mortgages that allowed for quick escalation of the interest rate.

Thanks to an upswing in delinquencies and foreclosures -- and new scrutiny from federal regulators and Congress -- mortgage lenders have tightened their standards for granting loans. And with home prices rising modestly, if at all, appraisers are tightening their opinions on value. Borrowers stuck with mortgages that are more expensive than they had expected can no longer count on a quick home sale to bail them out of the deal. It's pay up -- or refinance into a loan with better terms.

Lender standards tightening

If you're looking for a refinance, whether it's because your current mortgage will soon adjust to a higher interest rate or because you'd like to borrow extra cash against your built-up equity, you can expect lenders to be more demanding about your credit, your ability to document your income and the appraised value of your home. They are less likely to OK new mortgages if the monthly payments consume more than 28 percent of the borrower's monthly gross income, or if, combined with payments on other loans, debt repayment consumes 36 percent or more of income.

Even if you're not looking to take cash out, lenders are likely to demand that your new loan account for less than 100 percent of your home's current value, even if you bought it only a couple of years ago with a zero-down-payment loan.

Considering a refi? Be proactive

One of the first steps a would-be refinancer must take is to determine whether there is a prepayment penalty on their current mortgage. "Prepayment penalties are very common," says Lez Trujillo, national field director for Acorn Housing, a nationwide homeownership counseling service headquartered in Chicago. "When you got such low interest rates with an adjustable-rate mortgage, the hook was you couldn't get out of it very soon," she says. Penalties can equal six months of interest payments, and they're triggered if you refinance (and sometimes even when you sell the home) within the first two or three years of the loan.

Acorn Housing, as well as other counseling agencies approved by the U.S. Department of Housing and Urban Development, works with some of the largest U.S. mortgage lenders to help troubled borrowers with low and moderate incomes avoid foreclosure. "A number of lenders are waiving prepayment penalties," says Trujillo. "It doesn't hurt to talk to the lender and ask them to waive it." However, prepare yourself to be told that your mortgage has been sold to investors (which happens frequently), and that a waiver could only be granted with the OK of the investor.

Trujillo says lenders may be willing to work with borrowers to help avoid delinquent payments and foreclosures. The key is to get the process moving before you fall behind on payments. "If borrowers are on time with the loan they should pick up the phone and see if the lender can help them," she recommends, adding that to avert foreclosures, some lenders have approved interest-rate reductions without requiring the owner to refinance.

Tread cautiously and confidently

Of course, borrowers trying to escape difficult loans before their payment adjusts to an even higher rate need to be careful that a refinance would truly offer more than temporary respite. Even if you had subprime credit before, don't assume that's all you can qualify for now. There's no need to start your search with lenders (or mortgage brokers) that target credit-challenged borrowers; start with mainstream lenders and see what they can offer you. "Not all brokers are bad, but most of the abuses we've seen are from brokers," says Trujillo. "People have to be careful who they work with!"

All refinancers need to take into account all the costs involved with getting a new mortgage. Even if a loan is billed as a "no-cost" refinance that really means that the transaction expenses have been rolled into either the new interest rate or into your new loan balance. Refinance expenses usually include appraisal fees, document processing expenses, and fees for a new title search and title insurance. You may be able to snag a cheaper "re-issue" rate on the title insurance if you go with the same company that did the title work just a couple of years ago. Be sure to ask for it.

Keep in mind that with a refinance, any up-front mortgage-interest points you pay cannot be deducted from your taxable income in the year of the refinance. With a refinance, deductions for points paid must be spread out over the life of the loan. 

How about you? Are you concerned about your mortgage? Pleased with the one you have?
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