May 10, 2006

When You Owe More on Your House than It’s Worth

I’m not going to say I told you so, but I did tell you.

Yes, I warned everyone about the danger years and the problems with interest-only and no-money-down loans. Now we’re starting to see the impact of them as interest rates rise and housing prices stabilize (or fall in some areas).

This piece from Money Central highlights the problem — and how it’s leaving people owing more than their house is worth. The details:

Rising interest rates would put a strain on homeowners with adjustable-rate mortgages in any economy. But the situation is growing critical for millions of borrowers who are upside-down, owing more on their homes than they’re worth.

Many of these homeowners may soon face a can’t pay, can’t sell, can’t refi situation that could lead them to lose their homes.

Nearly one in 10 households with a mortgage had zero or negative equity in their homes as of September 2005, according to First American Real Estate Solutions, an arm of title-insurance company First American Corp. The study of 26 million homes in 36 states and the District of Columbia found that one in 20 home borrowers was upside-down by 10% or more.

The situation is even grimmer for recent borrowers. Of those who bought or refinanced homes in 2005, 29% had zero or negative equity, and 15.2% were underwater by 10% or more.

Interest rates on about a quarter of all mortgage loans outstanding, or $2 trillion, are scheduled to reset this year and next, according to Economy.com. Homeowners who opted for extremely low teaser rates in recent years could see their payments eventually double, said Christopher Cagan, First American’s director of research and analytics.

Defaults and foreclosures are already on the rise, thanks in part to higher interest rates, cooling real-estate markets and overextended borrowers. Nationally, 117,259 properties entered some stage of foreclosure in February, according to foreclosure-monitoring firm RealtyTrac, a figure that’s up 68% from February 2005.

This is exactly why people need to follow a solid, reasonable formula when buying a house. Unfortunately, many people don’t do this. Instead, they borrow the maximum they can, stretching every part of their personal finances to the near breaking point, to buy their dream house. Then, they compound this by borrowing in other areas like fiends — for new cars, new furniture, vacations, and the like. So when something unexpected happens (interest rates rise, an emergency comes up, an unplanned expense occurs, a drop in income hits them, the washer, dryer, stove, etc. breaks, etc.), they have no cushion left and there is a financial emergency. I’ve seen this happen time and time again. Unfortunately, it seems more like the rule nowadays than the exception.

This article offers some tips for people looking to try and weather the current financial storm:

• Avoid risky loans.
• Consider locking in.
• Protect your equity.
• Control your debt and protect your credit.

This is decent advice, but for many it’s too late. I hope it’s not too late for you. If it’s not, please get your financial house in order and on firm ground before anything like the above situations threatens you or your home.