Speaking before the Society for the Encouragement of Multiple Marriages, Gingrich explained that “we are at a point in our Nation’s history where we must turn back to our corporate roots for salvation. We have a massive national debt, including the $4.35 billion added under the Bush Administration, but we also have no need to increase personal or corporate taxes. The solution is not less debt, it’s better debt, and what could be better than an interest-free account with Tiffany’s?”

Gingrich — who has had a credit balance with the famous New York jeweler for as much as $500,000 — said that extensions of credit without interest were common for business leaders, celebrities and politicians.

“Look, not that it’s anyone’s business, but those who can afford interest don’t pay it,” said the former Speaker of the House. “Think about it this way: If you have bad credit you pay high interest, if you have good credit you pay low interest and if you’re among the national elite you pay no interest. What could possibly be more elite than our federal government?”

The book author and historian also explained that a zero tax rate was part of our national heritage.

“The Founding Fathers were plainly against income taxes. You can look throughout the Constitution and the Declaration of Independence as they were written by Washington, Jefferson and Reagan and you won’t find a word about the 16th Amendment.

“We have plainly corrupted our financial system,” said Gingrich. “The best resolution would simply be to tell China and the oil-producing states that our debt is canceled. That would save $6 trillion right there. What are they going to do? Seize Iowa? We should just explain that it’s an overdue currency adjustment, maybe get a telephone company to send them a bill. It would take years before they could decipher all the charges.”

“Alternatively,” said the presidential candidate, “if foreigners really wanted to trade $6 trillion for three million acres of Iowa real estate that could be a win-win for everyone, especially when they find out about the energy-efficiencies of ethanol. As to the rest, just put it on a tab with Tiffany’s.”

Gingrich Offers Deficit Solution: Credit From Tiffany’s is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: comedy, Constitution, debt, Declaration of Independence, Gingrich, Iowa, Jefferson, marriages, Newt, Newt Gingrich, Reagan, satire, taxes, Tiffany, Tiffany's, Washington

Killelea is a leading seer and prophet for a financial movement which thinks traditional real estate strategies are done and over. His website — the hugely-popular Patrick.net — is a national forum for the renting-is-better trend, a place where he and thousands of others make the case for new thinking and provide example after example of local rental opportunities.

In the past it would be easy to dismiss Killelea because rising home prices made real estate attractive. Figures from the New York Times show that in 1968 the typical house was valued at $22,600, a figure which rose to $219,000 by 2006. (See: Will the Fed Reverse the Housing Slump? September 19, 2007)

But the numbers from the Times also show something else: In 1968 it would take a typical buyer 2.9 times his or her annual income to buy a house. By 2006 the same house would cost 4.5 times annual income.

Killelea believes home prices have soared to a point where they no longer make financial sense, that real estate values are likely to decline further and that in most situations renting is now a better option than owning.

The Market Slumps

After decades of good news real estate trends started to change in 2007 when large numbers of distressed homes began to appear and force down home prices. RealtyTrac reports that there were 885,468 foreclosure filings in 2005, a figure which reached 2,203,295 in 2007 and has continued to climb.

The government says that home prices in November 2010 were down an average of 14.9 percent from the 2007 peak. Some regions, of course, have had even steeper declines — think of areas in California, Florida, Nevada, Arizona and Michigan.

The result, says Killelea, is that times have changed. New conditions require new thinking and in most cases that means ownership is out and renting is in.

“Prices did inflate for a long time as the US industrialized and the population growth rate was high,” says Killelea, “but lately the US is losing its industrial base to China, and US population growth has slowed. This makes it unwise to count on similar house price inflation in the future, especially in areas where prices are already far beyond the cost of renting an identical house.”

The Case For Renting

On his site, Killelea argues that “it’s usually still much cheaper to rent than to own the same size and quality house, in the same school district.

“On rich neighborhoods, annual rents are often 2.5 percent of purchase price while mortgage rates are 5 percent, so it costs twice as much to borrow the money as it does to borrow the house. Renters win and owners lose! Worse, total owner costs including taxes, maintenance, and insurance come to about 9% of purchase price, which is more than three times the cost of renting and wipes out any income tax benefit.”

In the past, the premium many buyers saw for ownership was justified by the idea that a home was not just shelter, it was also likely to be an investment that produced consistent gains in value. In many cases the value of real estate increased more than the rate of inflation, meaning that over time additional buying power — the real measure of wealth — was being created.

The catch is that now the justification for real estate ownership is missing in many markets. Prices are not rising before inflation or after. When home values will again begin to rise is unknown and unknowable.

When to Buy

Killelea is not an absolutist, someone who believes renting is always the better choice when compared with ownership. Instead, he makes two central arguments:

First, he says consumers should stick to basics and seek to avoid debt when possible.

“The traditional banker’s rule of thumb is that a house should not cost more than three times a household’s gross annual income. On a monthly basis, I think 30% of take-home page is reasonable,” he says.

Killelea’s view is actually more liberal than traditional lending standards. Conventional loans, for example, typically require that a borrower spend no more than 28 percent of his or her monthly income for mortgage principal, mortgage interest, property taxes and property insurance (PITI). This is the so-called “front” ratio that lender use to qualify borrowers. The “back” ratio includes the front ratio plus recurring costs such as monthly payments for auto loans, credit cards and student loans. The back ratio for conventional loans is 36 percent of monthly income.

Second, Killelea argues that even if the financing numbers are right, even if a borrower can spend less than 30 percent to own, there is still a need to look at whether it’s cheaper to own or to rent over the ownership period.

“Living in California did really force the whole rent vs buy issue into my head, because the prices were and still often are so absurd, like two to three times as much to own as to rent the same thing. Had I lived elsewhere, I probably would not have thought about it as much.”

A False Bottom

When asked if real estate values have generally reached a false bottom, if prices could go lower in many areas, Killelea says “yes, I do think we reached a false bottom again, and we have done so many times since 2006. I do believe house prices in most markets will fall in 2012, but that the percentage declines will be larger in more affluent areas. The bottom will be here when it is distinctly cheaper to own than to rent the same thing.”

“I think rates will go higher in spite of the increasingly desperate manipulations of the Federal Reserve,” he says. “But that doesn’t make it a good time to get a mortgage at all. The ideal time to buy is when interest rates are at a peak, which excludes competing buyers, and to buy then with all cash. Then you get few competing buyers, a low price, and no risk of defaulting.”

Yet even if buying conditions are not ideal, Killelea expects there will be no shortage of real estate purchasers.

“The basic psychological drive to own at any price will nonetheless cause millions of people to keep making bad financial decisions. But at least some people will do the math and see why they should wait until they find a really good deal.”

Real Estate Seer: Renting In, Mortgages & Foreclosures Out is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: Arizona, California, debt, deflation, Federal Reserve, Florida, foreclosure, Foreclosures, home, inflation, Killelea, Michigan, mortgage, Nevada, Patrick Killelea, prices, real estate, RealtyTrac, Rent, renting, value, wealth

Huh? Are your kidding me?

According to the Federal Housing Finance Agency (FHFA), home prices in the third quarter fell by 3.2 percent from a year earlier. At the same time, the Federal Reserve says that in the third quarter America’s personal net worth increased by $1.2 trillion. The idea is not so much that income grew, instead what’s happened is that debts are declining:

• Household debt contracted at an annual rate of 1¾ percent in the third quarter, the tenth consecutive quarterly decline.
• Home mortgage debt fell at an annual rate of 2½ percent in the third quarter, about the same as in the previous quarter.
• Consumer credit was down 1½ percent, after a decline of 3¼ in the previous quarter.

You can see the same sort of thing by looking at credit card spending. As the end of October credit card debt was valued at $800.5 billion. That’s a lot of money, but down substantially from the $957.5 billion that was outstanding in 2008. Reducing credit card debt by $150 billion likely lowers annual interest costs by $30 billion — money that can now be spent or saved on things more worthy than credit card interest.

Falling credit card use is a big deal because the Federal Reserve also reports that three-quarters of all non-cash spending is done electronically. So, if three quarters of all non-cash spending is electronic, and if credit card spending is down, have consumer purchase levels shriveled? In an economy which gets two-thirds of its purchasing power from consumers you’d like to see more consumer spending, especially spending which does not create additional debt.

Home prices dip, mortgage loan debt falls 2.5% yet households gain $1.2 trillion in new wealth is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: debt, decrease, Federal Reserve, household, loan, mortgage, wealth

A new study by TransUnion shows that the use of bank-issued, general purpose credit cards has fallen significantly during the past year. “This deleveraging,” says the company, “is believed to be due in part to charge-offs in the higher risk segments of the population, more conservative spending in the low-risk segments, and significant efforts by consumers across the board to maintain the health of their credit card relationships as a financial cushion.”

TransUnion says “consumers with higher incomes were just as likely as consumers with lower incomes to suspend their use of this payment option.”

“In 2009,” says TransUnion’s Ezra Becker, “well over 70 million consumers did not have an active, general-purpose bank issued credit card. During the course of one year, more than 8 million additional consumers joined these ranks, making it one of the fastest growing consumer segments. Consumers who do not have or use bank-issued, general purpose credit cards still have a need for other payment vehicles, a fact which is beginning to attract significant attention from credit and debit providers alike.”

Mortgage Ratios

Credit card debt is one of the factors considered when individuals apply to finance or refinance real estate. Lenders look at the “front ratio” and “back ratio” when qualifying borrowers. The front ratio includes the monthly cost for mortgage interest, mortgage principal, property taxes and property insurance — also known as PITI. The back ratio includes the front ratio plus regular monthly costs such as student loans, car payments and credit card obligations.

For instance, FHA guidelines allow ratios of 31/43. If the Smiths earn $6,000 per month before taxes it means that as much as $1,860 can be used for housing costs (the front ratio) while $2,580 can be used for housing costs plus monthly obligations.

In this example, the Smiths can spend as much as $720 per month on consumer debts ($2,580 less $1,860). That’s not a lot when one figures the cost of auto debt, student loans and such.

No Use – But Rising Balances

Credit card interest continues to accrue on outstanding debt whether or not a card is used. To lower monthly costs consumers must take two steps to get ahead: First, reduce if not pay off existing credit card balances. Second, not borrow from other sources such as checking account lines of credit.

Discontinuing the use of credit cards can also be important for another reason: Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 credit debt is not forgiven if you spend $750 or more in the 70-day period before seeking bankruptcy protection.

Other Findings

For the third quarter of 2010 TransUnion also found:

• The incidence of credit card delinquency was highest in Nevada (1.28 percent), followed by Florida (1.09 percent) and Mississippi (1.06 percent). The lowest credit card delinquency rates were found in North Dakota (0.48 percent), South Dakota (0.53 percent) and Nebraska (0.56 percent).
• Only two areas showed an increase in credit card delinquency — the District of Columbia (19.67 percent increase) and Mississippi (1.92 percent increase). The two areas of the country with the largest quarter-over-quarter drop in delinquency were Alaska (-19.2 percent) and Nebraska (-17.6 percent).
• National average credit card borrower debt (defined as the aggregate balance on all bank-issued credit cards for an individual bankcard borrower) edged upward for the first time in six quarters by 0.28 percent to $4,964 from the previous quarter’s $4,951, but down 11.54 percent compared to the third quarter of 2009 ($5,612).
• The highest state average credit card debt remained in Alaska at $7,159, followed by Hawaii at $5,716 and North Carolina at $5,640.
  The lowest average credit card debt was found in Iowa ($3,807), followed by North Dakota ($4,103) and South Dakota ($4,196).
• All but 15 states showed an increase in average credit card debt from the prior quarter. The largest increases in average credit card debt over the previous quarter occurred in West Virginia (2.81 percent), Wyoming (2.2 percent) and Hawaii (2.19 percent).
• On a year-over-year basis, national credit card originations increased for the first time since the recession began in late 2007. Only nine states showed decreases in originations since the third quarter of 2009. The states with the greatest year-over-year increases were Delaware (21.3 percent), Oklahoma (16 percent), and Pennsylvania (15.8 percent).
• The areas with the steepest declines in year-over-year credit card originations were the District of Columbia (-10.3 percent), Minnesota (-9.6 percent), and Michigan (-4.2 percent).
• As credit card delinquency trends differ between the national and state economies, metropolitan areas can also show different credit dynamics relative to the state level. Approximately 77 percent of metropolitan statistical areas (MSAs) showed a decrease in their 90-day credit card delinquency rates since last quarter, which is generally consistent with national trends.
• The area with the largest drop in delinquency since the last quarter was the Dubuque, Iowa Metropolitan Statistical Area (-48.4 percent). The area with the largest increase in delinquency since last quarter was the Lewiston, ID-WA Metropolitan Statistical Area (92.7 percent).

8 million consumers drop credit cards, improve mortgage standing is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: back ratio, bankruptcy, credit cards, debt, finance, foreclosure, front ratio, guidelines, lender, loan, mortgage, PITI, qualification, refinance

A new study by TransUnion, the big credit reporting agency, says there is now a new payment hierarchy where consumers pay their credit cards before their mortgages.

“The percentage of consumers current on credit cards and delinquent on mortgages first surpassed the percentage of consumers current on their mortgages and delinquent on credit cards in the first quarter of 2008,” says TransUnion. “This ‘flip’ is representative of the change in the conventional wisdom around the payment hierarchy, or which debt obligations consumers would choose to pay first.”

“The implosion of the mortgage industry over the last 24 months, the resetting of adjustable-rate mortgages and the weak job market have all come together to redefine how consumers are managing their finances and meeting (or not meeting) their credit obligations,” said Ezra Becker, director of consulting and strategy in TransUnion’s financial services business unit. “The insight gained through this analysis reveals a lot about changing consumer preferences. The financial services industry must recognize and adjust to the payment hierarchy shift with judicious modifications to business models, new assessments of specific areas of risk, and by strategic revisions to acquisition and account management strategies.”

Consumer Logic

Traditional thinking said that consumers put credit card bills ahead of mortgage debt. Here’s why: If you don’t pay your mortgage you’ll lose your home. If you don’t pay your credit card bills you might get sued, your credit score will fall and you may be hounded by debt collectors.

But honestly, how is someone going to take back that trip to Bermuda?

Foreclosure States

TransUnion says “within California, the percentage of consumers delinquent on their mortgages but current on their credit cards increased from 3.5 percent in Q3/2007 to 10.2 percent in Q3/2009 (a 191 percent increase). In Florida, this same variable increased from 5.1 percent in Q3/2007 to 12.4 percent in Q3/2009 (a 143 percent increase). In this same timeframe, the United States experienced a 68 percent increase (from 4.0 percent in Q3/2007 to 6.6 percent in Q3/2009).

“In contrast, the number of California consumers delinquent on their credit cards but current on their mortgages declined from 3.3 percent in Q3/2007 to 2.7 percent in Q3/2009. In Florida, this variable declined from 5.0 percent in Q3/2007 to 3.9 percent in Q3/2009.”

It’s just a guess, but maybe people are making their credit card payments because they’re using credit to buy groceries and such when faced with a job loss or some other form of income reduction. Otherwise, it still seems logical to pay the mortgage and keep a roof over your head before paying credit card debt.

Credit Cards Or Mortgages: Which To Pay First? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: credit card, debt, hierarchy, logic, mortgage, payment, TransUnion

The original HUD-1 was developed as a by-product of the Real Estate Settlement and Procedures Act of 1974 — or, as it’s usually called, RESPA. Prior to 1974 settlement forms could be different, meaning that it was very difficult to compare costs or to know what was deductible for tax purposes in the year of the transaction.

So what do we get after 36 years? The new HUD-1 is a vast improvement over the old model. It’s three letter-sized pages long rather than two legal pages, but there’s much more information in the new HUD-1. Buried in the form is an accounting of closing costs and perhaps even some write-offs. Buyers will find the full and complete cost of buying real estate while sellers will see how much cash (if any) they’re getting from the transaction.

Page One

The first page of the form is a summary of the transaction. In effect, it translates the sales contract between buyers and sellers into hard numbers.

At the top of the form we first have administrative data such as:

• The type of loan (conventional, VA, FHA, etc.).
• The place and date of settlement (the date can be very important for tax purposes).
• The mortgage insurance case number (important if you’re ever facing foreclosure).
• The street address of the property. This is a concern because for great clarity and assurance the form would be better if it also included the legal address of the property.
• The name of the settlement (or closing) agent. The party that conducts the settlement is typically regarded as an agent of the settlement process. In other words, they do not represent you.

Page One, Buyer’s Side

The HUD-1 shows transaction costs for both buyers and sellers — you get to see what the other person’s information. More important you get to see your own.

On the right side of the first page we have buyer costs grouped by sections.

Section 100 — This is where buyers see the cost of the property and the cost of settlement (the figure found on line 1400). Combine the two and you get the gross amount — but not the final amount — due from the purchaser.

Notice that there can be some adjustments in this section. For instance, it may be that the seller has paid local property taxes in advance — those payments would be a credit to the seller and a cost at closing to the buyer.

Section 200 — As a buyer you may have certain credits to offset your gross costs. Credits include such things as your deposit, your new loan (for closing purposes the mortgage is a credit to the borrower because it represents money brought into closing) and any additional financing.

In the 200 section you can also see adjustments which are a credit to the buyer. For instance, maybe the seller still owes some property taxes.

Section 300 — This is a re-cap of all costs and credits. If you take the gross amount due from borrower (line 120) and subtract the buyer’s credits and cash you then get the total cash due to — or from — the borrower.

Most buyers, of course, will need to bring “cash” to settlement. By “cash” what most settlement agents really want is a certified check or a cashier’s check. Also, it may be possible to wire funds to the closing agent. Always ask the settlement provider well in advance of closing how payment can be made.

Gifts: To assure lenders that you are not somehow getting a secret loan from someone, it’s best to have closing funds in your name and on deposit for at least 90 days. If you are getting a gift to close, ask your lender how the gift is to be documented and precisely follow the lender’s instructions.

Page One, Seller’s Side

Settlement is a moment of truth for owners, the time when you find out exactly how much or how little you’re getting from your sale.

Section 400 — The sale price of the house, plus the cash paid for any personal items, are shown here as credits to the owner.

Also in this section are adjustments — credits for property taxes and other costs paid in advance.

Section 500 — If any mortgage debt remains unpaid it shows up here as a cost to the seller. Also, the costs of closing (line 1400) are here as a deduction as well as any adjustments for such costs as unpaid property taxes.

Section 600 — If we take the gross amount due to seller (line 420) and subtract the seller’s closing costs (line 520) we can then see how much cash the owner will get from closing (or, how much cash is needed to close if the seller is upside-down).

Practices around the country regarding cash to owners at closing vary. In some areas there are “wet” settlements where the owner gets a check at closing, in other areas there are “dry” closings where it takes a few days to get a check because it takes time for the lender to fund the transaction and paperwork to be recorded. In some jurisdictions there are rules requiring the disbursement of cash with a few days. For specifics, speak with your settlement agent.

Page Two

On the second page of the new HUD-1 we have a series of sections which show costs that may be paid by either buyers or sellers — or split between them. In other words, these are costs which can be negotiated when a sale offer is made. For instance, in a slow market a seller might agree to pay all transfer taxes. In a hot market, the buyer might pay.

Section 700 — If one or more real estate brokers are involved in the transaction, this section will show the compensation to each broker and the cost, if any, to buyers and sellers.

Section 800 — Getting a mortgage is hardly free. When the buyer applied for financing the lender provided a Good Faith Estimate of Closing Costs (GFE) on the new form developed by HUD. This section shows such costs as points, origination charges, appraisal fee, credit report and tax service. Borrowers should check the numbers at closing with the estimates provided in the GFE. The costs shown on lines 801 (origination charge), 802 (points), and 803 (adjusted origination fee) must be the same as the GFE.

Please see our guide to the new Good Faith Estimate form to see how it’s coordinated with the equally-new HUD-1.

Section 900 — Closing is scheduled at a time which is mutually-agreeable to the buyer and seller. That time, however, will mean that for such items as interest, mortgage insurance premiums and homeowner’s insurance there will likely be a need to make some payments for daily costs in advance until the next billing period.

Section 1000 — If you purchase a home with less that 20 percent down the lender will likely require that you pay additional amounts each month for property taxes and insurance. This money is held in an escrow or trust account and then paid out as the bills come due.

If you will have an escrow account then the lender will typically collect money in advance from borrowers to assure that the escrow account is properly funded.

Section 1100 — As part of the buying process, sellers typically promise to deliver good, marketable and insurable title — and buyers should want nothing less. This section shows the costs for title insurance — both lender’s and owner’s coverage.

Lender’s cover — which is required by lenders if you finance the purchase — protects you up to the remaining loan balance in the event of a title claim. In other words, it protects the lender.

Owner’s coverage protects you if there is a title claim up to the purchase price of the property — in other words the loan amount plus your equity. Be aware that some title insurance policies have an inflation rider so that the value of the coverage can actually increase over time. For specifics, speak with your title agent.

Also, take a look at line 1107. This shows the commission paid to the settlement agent for providing title insurance.

Section 1200 — This is where you can see how much state and local governments are getting from the transaction. Governments are elated when homes are sold because such transactions are a major source of revenue. Government taxes can includes such things as deeds, releases, transfer taxes, state taxes, stamps, etc. Call it what you will, a tax is a tax.

Section 1300 — This is where you can find additional settlement costs.

Section 1400 — The total costs to close — this number also appears on lines 103 and 502 on the first page.

Page Three

The third page of the new HUD-1 is partially a confirmation that the costs outlined in the Good Faith Estimate are what you’re actually paying — or pretty close.

Some quoted costs on the GFE cannot be changed, some can be changed as much as 10 percent and some can simply change with the winds.

Also shown on page three is a recap of your loan including the mortgage amount, interest rate, loan term, ARM-related terms (if any), prepayment penalties (if any), balloon payments built into the loan (if any) and related matters.

IMPORTANT: Always keep your closing papers in a safe place for tax reasons and to assure that your loan terms are actually the same as disclosed on the HUD-1. For questions regarding closing issues, speak with your real estate broker, mortgage lender and closing agent. Be aware that some costs found on a HUD-1 may be tax deductible — for specifics speak with a tax professional.

How To Read The HUD-1 is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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For details, speak with loan officers.

Do lenders count child care as a monthly “debt?” is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: care, child, cost, debt, loan, mortgage, qualification, qualifying

If an unpaid debt is on your credit report a lender will ask for an explanation. You can then write that there was a debt, there was bad judgment, you realize you were wrong, you now have a better understanding of credit and yes, you will pay off the debt. In other words, “Dear Lender: I goofed and it won’t happen again.”

If the matter happened several years ago but the debt has since been repaid it should not be an issue to lenders if your credit during the past two or three years is otherwise good.

However, why raise the issue with lenders? The debt has to be repaid anyway, so why not pay it off on time and without a penalty or credit report ding?

How Will A Mortgage Application Be Impacted If I Don’t Pay My Credit Card? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: card, credit, debt, explanation, report, unpaid

Answer: The debt and pay-off will likely show up on credit reports, so a lender will ask for an explanation. You can then write that there was a debt, there was bad judgment, you realize you were wrong, you have paid off the debt, and you now have a better understanding of credit. In other words, “Dear Lender: I goofed and it won’t happen again.” Because the matter happened several years ago, it should not be an issue to lenders if otherwise your credit during the past two or three years is good.

How Can I Deal With Unpaid Credit Debt? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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I have a toxic loan but why worry? After four years or so — just before the monthly cost of this loan doubles — I’ll just go out and get another interest-only or option ARM, begin the start rate all over again and then have low monthly payments for another four or five years. Since this is so easy, why be concerned?

“The idea of refinancing one toxic loan with another — superficially at least — offers a certain element of logic and reason,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the largest marketplace for foreclosure properties.

“But when you look at the potential liabilities it becomes clear that a strategy of repeated toxic-loan replacement will be a formula for disappointment if not disaster for many borrowers.”

With a typical interest-only mortgage the borrower can elect to make interest-only payments for the first five years. With a $300,000 loan at 6.25 percent the monthly cost for principal and interest during the first five years would be $1,562. At the end of five years — having paid interest worth $93,750 — the loan balance remains $300,000.

After five years the loan must be amortized; that is, monthly payments must be sufficient to pay down the loan over the remain loan period — 25 years in this example. Assuming the interest rate does not change — a wildly implausible assumption if the loan is adjustable — the new monthly payment for principal and interest will be $1,979.

Of course, if the interest rate rises then the numbers begin to change radically: The monthly cost would reach $2,120 at 7 percent and $2,315 at 8 percent.

The situation with an option ARM could be substantially worse. With such financing borrowers during the first five years can make monthly payments sufficient to repay the loan in 30 years or 15 years. They can also make interest-only payments or they can make low payments which produce “negative amortization” — an expression which means the monthly payment is insufficient to cover even the cost of interest, so what’s not covered is added to the loan balance.

If we have a $300,000 option loan with a 6.25 interest rate and a 1.25 percent start rate, the initial payments for the first five years would be $1,000 per month. Of course, this payment would mean that $563 in interest was not being paid, an amount added to the loan balance.

After 60 payments the loan amount would be nearly $325,000, the loan would be re-set and the minimum monthly payment for principal and interest would be $2,126 — assuming (foolishly) that interest rates never rise.

Okay, so here we have two loans which both feature wondrously-low monthly payments during the first five years. If an owner doesn’t sell during the past five years, why worry about higher monthly payments when such loans can be refinanced with new mortgages that again offer low monthly payments?

Here are eight reasons why refinancing “nontraditional” loans with a new round of similar mortgages may be destined to fail.

First, someone who qualified for financing five years ago might not qualify today. A job may have been lost, credit may have been damaged or income may have declined.

Second, the house may not support a full refinancing, especially if the loan’s principal amount has increased. Real estate values do not always rise and they do not always rise in all places. There’s no guarantee that a home will have sufficient value in five years to justify the loans available today. If a home cannot be refinanced in full, an owner would need cash to pay off any part of the old loan which cannot be refinanced. Of course, if an owner does not have that cash then the first loan cannot be refinanced.

Third, income qualification standards may change. It may be that today’s income and debts will be sufficient to qualify for our model $300,000 loan, but if loan standards tighten then even if incomes remain stable or increase it’s possible that a borrower will not be able to fully refinance an existing debt.

Fourth, equity requirements may evolve. Today it’s fairly easy to buy with 5 percent down — or less. But there’s no assurance that more won’t be required. For instance, if lenders in five years require 10 percent equity, then someone seeking to refinance a $300,000 loan would need a home that appraises for at least $333,333.

Fifth, interest-only and option ARM financing may not be widely available in five years. As lenders get more experience with “nontraditional” loans they may limit such financing to borrowers with exceptional credit and resources — and some may stop offering such loans entirely.

Sixth, interest rates could rise. We’re currently in a period where interest rates are low by the standards of the past fifty years, but it’s entirely possible that rates could rise sharply in the future. Even a minor increase. say from 6.25 percent to 7 percent or 7.5 percent, would strain many budgets — and bankrupt others.

Seventh, owners may need to move for a new job or another reason — even if the value of the home after marketing costs is less than the mortgage. In such a situation an owner might be required to bring cash to closing or could be forced to accept a loan from the lender for the missing money. In one case you would have less cash to purchase a replacement property while in the other you would have less credit to secure another mortgage.

Eighth — and perhaps most importantly — “the financial purpose of owning real estate is not to create perpetual debt,” says RealtyTrac’s Saccacio. “Instead, the path to wealth for most people has been to have a home which appreciates in value, debt that’s reduced over time and monthly housing costs that eventually decline relative to income. This is the formula which has been used by households nationwide to provide for college educations, retirements, better living and inter-generational inheritances.”

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Published originally by RealtyTrac.com during December 2006 and posted with permission.

Toxic Loans & The Art of Denial is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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