The best moves in mortgages in 2009

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2008 was the year of foreclosures, and when “underwater” entered every homeowner’s lexicon. 2009 will be the year of refinances and mortgage modifications.

Viewed from hindsight, the mortgage mess seems inevitable: Absurdly loose credit from 2002 to 2007 led to a bubble in house prices; scores of subprime lenders went out of business in 2007 as the risks caught up with them; and the misery spread to homeowners in 2008.

As home prices fell, millions of homeowners discovered that they now owed more than their houses were worth. They were unable to refinance and even unable to sell. Delinquencies (defined as house payments at least 30 days late) soared.

Number of delinquent borrowers
In September 2007, roughly 1 in 18 borrowers were delinquent; in September 2008, the delinquency figure was about 1 in 14.
Source: Mortgage Bankers Association: Quarterly National Delinquency Survey)

As the recession matures in 2009, more people are going to fall behind on their mortgage payments. At the same time, the federal government is trying to hold down mortgage rates. And house prices continue to fall. These three factors limit the smart moves you can make in 2009 with your mortgage and equity debt.

2009 smart moves: Buy a house

House prices have been falling in most places. In declining markets, people have trouble deciding whether to buy a house now or wait for prices to fall further. Instead of getting stuck on the buy-or-wait question, smart consumers consider other questions first:

1. Have we put our financial house in order?

Not long ago, the best mortgage deals were offered to borrowers with credit scores of 720 or higher. Nowadays, that threshold has risen to 740 for a lot of lenders. The necessity of a higher credit score is just one consequence of the mortgage debacle. Lenders have tightened their requirements in other ways, too.

During the boom years, many applicants merely stated their incomes, without having to provide documentation. Those days are gone. Low-documentation and no-documentation loans are rare. Expect to provide paycheck stubs or tax returns (or both) to demonstrate that you earn what you say you earn.

The lender will want to see that your expenses are in line with your income. You might have to provide bank statements to show where the money goes. If a big chunk of your monthly income goes toward debts for credit cards, cars and college, the lender might constrain the amount you may borrow.

1. Have we saved enough for a down payment?

During the credit and housing boom, people routinely bought houses with no money down. Piggyback loans were the norm, as homeowners avoided mortgage insurance. Nowadays, substantial down payments have made a comeback, and so has mortgage insurance.

A few low down payment programs are still available; all of them courtesy of the federal government. The Veterans Administration guarantees mortgages with no down payment, and so does the Department of Agriculture’s Rural Housing Service. There are restrictions on who is eligible for those loans, where the loans are available, and for how much.

More people are eligible for Federal Housing Administration-insured mortgages, which require down payments as low as 3.5 percent.

Outside of those federal loan programs, most lenders require significant down payments. The requirements vary by lender, the type of dwelling, and where it is. A few creditworthy people might be able to buy houses with 5 percent down, but a minimum 10 percent down payment is more common.

Mortage insurance companies won’t insure loans on Florida condominiums, so lenders require down payments of at least 20 percent. For jumbo mortgages in California, many lenders require a 30 percent down payment.

On top of that, the lender will want to know how you got the down payment money. Is it from personal savings? Was all or part of the money a gift from family? If some of the money was given to you, the lender will want to make sure you have enough savings and income to handle temporary financial setbacks.

3. Is this the right time in our lives?

Homebuyers, especially first-timers, should aim to own for the medium to long term. House prices have room to fall further in many — if not most — markets, and it could take years for prices to rebound. In short, it’s a bad idea to buy a house with the intention of selling it in two or three years. Doing so could be a money-losing proposition, especially after factoring in the costs of real estate commissions and taxes.

2009 smart moves: Refinance the mortgage

Elements within the housing industry flew a trial balloon in December 2008 to gauge public support for using the Treasury to cut mortgage rates to 4.5 percent. There was one catch: The low rates supposedly would be for purchases, not refinances.

Nevertheless, mortgage rates have dropped to levels not seen since the refinancing boom of 2003. The low rates sparked a refi boomlet in late 2008, but lots of homeowners were frozen out because their homes had lost equity.

About two-thirds of homes have mortgages. Of those, an estimated one-sixth are underwater — in other words, the owner owes more on the mortgage than the house is worth. These borrowers can’t refinance unless they have enough money saved to make up the difference — and then some, because they need some equity, too.

According to First American CoreLogic, almost one-quarter of mortgages nationwide were in the category of “near negative equity” in October 2008. These loans were not underwater (yet), but the owners had 5 percent equity or less. These borrowers might have trouble refinancing because of the paucity of their equity.

The squeeze caused by falling home values will have a relatively big effect on homeowners with good credit who got adjustable-rate mortgages sometime in 2004, 2005 and 2006. These are the people who will have an incentive to refinance out of their ARMs and into fixed-rate mortgages (a process that Quicken Loans chief economist Bob Walters calls “dis-ARMing”).

Most prime adjustables during the 2004-2006 period were 3/1 and 5/1 ARMs. These loans had introductory rates that lasted for three or five years; after that the rates adjust (or “reset”) annually. The date of that first rate reset peaked in the summer of 2008, but about half a million prime borrowers will see their first reset in 2009.

Prime ARM resets by month, number of loans

2009 smart moves: Modify the mortgage

One of the big questions of 2009 — politically, economically and financially — will be: How do we mass-modify mortgages to avoid foreclosures? Coming up with an answer won’t be easy.

A mortgage modification is an alteration of the details of the existing home loan. Usually, but not always, a modification is done after the borrower has fallen behind on the payments by 90 days or more. In a modification, the borrower keeps the loan — in other words, it’s not a refinance. Modifications usually are done when the house is worth less than the mortgage balance.

There are several ways to modify a mortgage. Sometimes the term is extended — for example, a 30-year mortgage is turned into a 40-year loan. In other cases, the rate is reduced. Or interest is charged on only some of the loan balance. Occasionally, in what’s called a “principal reduction,” the lender forgives some of the debt, so the borrower no longer owes more than the house is worth.

Modifications traditionally have been done one at a time, case by case. But skyrocketing demand for mortgage modifications will require companies to apply rules that apply to large swaths of borrowers. The rules will determine who gets a modification and who doesn’t. Controversy will result when “deserving” people don’t qualify for modifications, while some “undeserving” people do qualify.

When the government took over IndyMac, one of the country’s largest mortgage servicers, the Federal Deposit Insurance Corp. set up rules designed to encourage mortgage modifications. Since then, the government has required lenders, such as Citigroup, to adopt the FDIC’s mortgage modification rules as a condition for receiving federal aid.

It’s too early to know how successful the FDIC’s mortgage modification plan has been. Overall, modifications haven’t been all that successful. According to the Comptroller of the Currency, more than half of loans modified in the first three months of 2008 had fallen behind on their payments within six months.

FDIC Chairman Sheila Bair questioned the comptroller’s data, saying that it failed to distinguish “sustainable modifications versus cosmetic modifications.”

2009 smart moves: home equity

Because of declining home values, lenders became reluctant in 2008 to underwrite new home equity loans and home equity lines of credit. That trend is likely to continue through 2009.

In areas where home prices are falling fastest, lenders have been reducing the limits on home equity lines of credit, or even canceling the credit lines outright. The best advice on home equity debt is the most basic: Keep paying the monthly bills if you can.