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Lemon Loan

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Posted On: 11/12/2008

Q:Eighteen months ago I purchased a home. I specifically told the lender that I did not want an ARM. He sent me the paperwork for closing, and when it included an ARM I said I would not accept it. He told me a mistake had been made and that I should just tear up the paperwork.

I have now found out that my first loan is fixed but only for two years. The interest rate can go as high as 19 percent. I also have a second mortgage with a balloon payment. I have put $13,000 into improvements and made all of my payments, but I want a fixed-rate loan.

I'm a small-business owner and financed with a stated-income loan application. I cannot find a lender who will refinance my property; one suggested that I try a short sale. What can I do?

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A: Have you looked at the terms of the first loan? Does it have a stiff prepayment penalty if you refinance before the payment rises?

The lender will say that you accepted the ARM and the balloon note -- and will have a ream of paperwork to prove it. The good news is that since you're making payments you don't actually have a credit problem - yet. The catch is that if interest rates go up and monthly payments rise, or if time on the balloon loan runs out, then matters could change, and not for the better.

Did lenders refuse to refinance the property because the value has declined and you have no equity? If that's the case you won't be able to refinance unless you get a smaller loan -- and that means bringing cash to closing.

There is no good solution to your situation. In the best case interest rates will remain low and you'll be able to make the payments long enough to get the first loan refinanced without a penalty.

But more likely payments will rise. While there is no good solution to your situation take a look at the new financing available through the FHA, financing developed by Congress and designed to save some 400,000 families from foreclosure. Alternatively, speak with a CPA and see if it's possible to get a loan secured by your business or from a retirement account. If yes, the cash can then be used to reduce the loan amount needed to refinance. In all cases, keep making your payments to maintain your credit.

None of these are good options. A better choice would have been to refuse the financing offered at closing, even if it meant the loss of a deposit.

Q: We need a mortgage for a home we are building ourselves and which we have financed by ourselves to this point. The outside and most of the inside is finished. We don't have a final ceiling (we have drywall up, but the final will be wood planks) or permanent walls, no cabinets in the kitchen but we built a counter and storage space under the sink. The master closet is finished, and we are working on the master bathroom. We still need carpeting and some final flooring. All electrical and plumbing is finished. With everyone else losing their homes or just barely hanging on, you would think that the mortgage companies would be knocking on our door.

A: Let's imagine that you're a lender. As you point out, a lot of borrowers are delinquent or are being foreclosed, so as a lender you're going to be picky about the mortgages you make.

You are certainly going to demand a lot of paperwork, credit checks and verifications for income and employment. You also want to make sure that the property has more value than the loan because if the house must be foreclosed you don't want to take a loss.

And there is the problem. How does an appraiser value a home with missing cabinets, unfinished bathrooms and a lack of final flooring? You can't compare the home straight up with a finished house down the street, you have to adjust and deduct for the multiple items that have not completed.

To a lender there are big problems here. Does the property comply with local building codes? Is there an occupancy license? Most importantly, if the lender does give you the money how does it know the work will be completed?

The house is security for the loan -- but an unfinished house can be terribly difficult to sell even in good times. Given that times right now are troubled, an incomplete house is far down the lender's list of desirable properties.

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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