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Avoiding mortgage foreclosure

(Article by Jean Sherman Chatzky, Money Magazine, 30 October 2002)

More people are refinancing and pulling cash out of their homes than ever before. But some of them are spending that cash, going deeper in debt and having a tougher time than ever making their mortgage payments. And that explains why foreclosure is now at the highest rate ever. "Today" contributor and Money magazine editor-at-large Jean Chatzky has some advice on how to keep that from happening to you.    

WALL STREET GOT a big surprise when the consumer confidence index for October 2002 dropped to 79.4, the lowest level since 1993, and far below expectations. Why did it drop so far? A number of reasons — the declining stock market, the threat of war, a weak labor market — have all put a damper on consumers confidence. If in fact the number is not just an anomaly (and the fact that it dropped so far so fast has some economists thinking it’s a bit of an outliner) and consumers stop spending the nation could slip back into a recession. In the nearer term, it also leads us to believe the holidays will be pretty bleak.

More people than ever are refinancing and pulling cash — or equity — out of their homes. They call these loans cash-out refinances, and according to a new USA Today report, they’re expected to hit a record $785 billion in loans this year. How do people use the money they pull out?

About 1/3 use that money to consolidate high-rate credit card debt and car loans. Another 1/3 spend the money on home renovations. The rest of the money is spent on cars, vacations, education, and starting new businesses.  This spending has been an undeniable boon to the economy, which would have certainly struggled even more without this cash infusion. But even though refinancing has great benefits to consumers — many of us have reduced our interest rates to the lowest level in 30-plus years — refinancing has its downside.

It puts us deeper in debt. Result: Americans are having a tougher time than ever making their mortgage payments, according to a September survey by the Mortgage Bankers Association. Its data show that a record 1.23% of mortgages, or some 640,000 loans, are in foreclosure — with the lender moving to take the home from the borrower. That’s not only a significant jump over the 1% of loans in foreclosure last year at this time, but it’s the highest rate in 30 years of record keeping.

What’s behind the leap? There’s the slumping economy, of course. When unemployment rises, late payments aren’t far behind. But Mortgage Bankers Association economist Doug Duncan cites two other factors: the wider availability of credit to people who have in the past had trouble paying their bills, and a proliferation of such innovative mortgage products as interest-only loans, which — because they drive monthly payments artificially low — have encouraged people to buy bigger homes than they can afford.      The good news is that the chances of avoiding foreclosure are greater than they’ve ever been. Fannie Mae is now negotiating to let borrowers keep their homes in 53% of problem-loan cases, a sizable jump over the 35% it was “working out” five years ago. Other lenders are following suit for good reason: a foreclosure costs them $2,500 on average. Says Duncan: “Nobody wins in a foreclosure."

What should you do if you’re feeling pressed?

Explain why you’re having difficulty making payments, how long that difficulty will last and what will have to be done to resolve it. Be prepared to provide financial details, including monthly income and expenses. The goal is to get the lender on your side, says mortgage lender James Nutter Jr. of Kansas City, Mo. “So do not wait for the lender to call you. If you call them, they will look upon that as you trying to not shirk your responsibility.”

If you have yet to miss a payment, refinancing can ease your burden. You can lower your interest rate, extend the term of your loan (thereby stretching out your payments) or convert some of the equity in your home to a cash cushion you could use to get by.

If you have an FHA mortgage, your lender may be willing to let you make a partial payment — say, $700 instead of the full $1,000 you owe — without changing the terms of your mortgage. You typically can’t do that with a conventional loan. But if you call and say you’ve missed a payment, your lender may tell you that you can make that payment up by spreading it over the next few months.

If you can’t continue to pay at your current rate but you can pay something, your lender will generally try to work with you to come up with a payment that you can afford. This works a bit like a refinance without going through that process. You’ll pay back what you owe, but you may do it over a longer period of time or at a lower interest rate.   If after considering all these alternatives, staying in your house doesn’t look possible, try one of two other fixes. Neither will protect your house, but both can protect your credit rating. The first is called a “pre-foreclosure sale.” It will allow you to sell your property (while living there) and move on in an organized fashion. The second is called a “deed in lieu of foreclosure.” That’s when you give your house to the lender and the lender disposes of it. However difficult it may be, it’s key to your financial future that you face this problem head on. Nutter says, “The worst thing you can do is run and hide.”