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Same Deal or No Deal?

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Posted On: 01/28/2009

Q: My husband and I would like to buy a house, but we have no down payment. Our friends, who where delinquent on their mortgage, just renegotiated for a five-year, 3-percent rate even though they have no equity. We’d like to get the same deal. What’s the best way new homebuyers can take advantage of the special rates being offered to delinquent homeowners?

A: It would seem perfectly logical that if your delinquent friends with no equity can get 3-percent financing that you should be able to get the same deal. If the world were fair you would have a good case, but unfortunately what’s really happening here is neither fair nor open to you.

Your friends bought a home and for whatever reason have not been able to pay their loan. In such circumstances a lender would normally seek to foreclose, but if you’re in a market with many distressed properties the lender would take a huge loss. How big? One common figure is $40,000 per house – and that was before the mortgage meltdown.

The lender in this situation has no hope of making a profit from either the sale of the home or the sale of a nonperforming loan. The best solution, or perhaps the least awful, is to not foreclose but to instead keep the borrowers in the house for a few years. Hopefully over time values will return and the home can be sold for enough to cover the outstanding loan balance. Meanwhile, the lender has one less foreclosure on the books.

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Your friends were able to get 3-percent financing without equity because they have leverage with the lender – the lender will suffer a bigger loss if the house is foreclosed. You have no such leverage and therefore will not be able to get anywhere near the same financing.

One by-product of your friend’s delinquency and massive numbers of other delinquencies is that lenders are scared to make loans. They now want lots of money up-front from borrowers and they also want fully documented loan applications. If you were a lender you would insist on the same requirements.

Also, you might want to get more information about your friends’ new financing. For instance, does it allow for negative amortization? Does it have a prepayment penalty? What’s the interest rate after five years? The reason to ask is this: The State Foreclosure Prevention Working Group estimated in September that one of five modified mortgages was again in default.

Q: Has the Federal Reserve begun forcing lenders to verify loan applicants? Has the Federal Reserve now defined high-risk mortgages as unfair?

A: Last July the Federal Reserve “approved a final rule for home mortgage loans to better protect consumers and facilitate responsible lending. The rule prohibits unfair, abusive or deceptive home mortgage lending practices and restricts certain other mortgage practices.”

The rule creates a newly defined category of “higher-priced mortgage loans” secured by a principal residence. The Fed explains that protections for these “higher-priced” loans will:

• Prohibit a lender from making a loan without regard to borrowers’ ability to repay the loan from income and assets other than the home’s value. A lender complies, in part, by assessing repayment ability based on the highest scheduled payment in the first seven years of the loan. To show that a lender violated this prohibition, a borrower does not need to demonstrate that it is part of a “pattern or practice.”

• Require creditors to verify the income and assets they rely upon to determine repayment ability.

• Ban any prepayment penalty if the payment can change in the initial four years. For other higher-priced loans, a prepayment penalty period cannot last for more than two years. This rule is substantially more restrictive than originally proposed.

• Require creditors to establish escrow accounts for property taxes and homeowner’s insurance for all first-lien mortgage loans.

The new rule, says the Fed, will “take effect on Oct. 1, 2009. The single exception is the escrow requirement, which will be phased in during 2010 to allow lenders to establish new systems as needed.”

The new rule leaves gaping holes in the lending system. For instance, most loans are not “higher-priced” mortgages and between now and next Oct. 1 millions of fresh mortgages will be issued without the protections found in the new rule.

One can argue, of course, that had the new rule been in effect several years ago when “nontraditional” mortgage products first began to appear that we either would not have the current mortgage meltdown – or it would be far less severe.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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