How To Deal With Higher Mortgage Payments

As the housing market continues to cool, higher interest rates have increased the mortgage payments for homeowners who have adjustable rate loans, or ARMs, causing the number of them defaulting on their mortgages in default to rise.

On The Early Show Thursday, money maven Ray Martin spelled out the problem, and offered advice to homeowners finding it harder and harder to make their mortgage payments:

According to Moody's Economy.com, the percentage of mortgages with delinquent payments has risen nationally to 2.33 percent, the highest level since 2003. The metropolitan areas that saw the biggest increase in mortgage delinquencies include McAllen- Edinburg-Mission, Texas; Merced, Calif.; Fort Smith, Ark.-Okla.; and Las Vegas-Paradise, Nev.

It's expected that mortgage defaults — in which a borrower misses one or more payments on a loan — will increase when the economy weakens and job losses rise. Typically, higher job losses translate into a higher percentage of homeowners missing loan payments. At this time, the percentage of home loans in default at 2.33 percent is closer to the historical average.

But this time is different: The economy continues to add jobs and mortgage defaults are still rising. According to reports from loan counseling agencies across the nation, the main reason homeowners give for falling behind on their mortgage payments is not a change in personal circumstances, such as a job loss, but that they are not able to make the increased payments on their ARMs.

Pick-A-Payment Mortgages

One form of mortgage — the so-called Option ARM — is especially painful to homeowners. Option ARMs allow the borrower to pick from four payment options, the lowest being an amount that is only a portion of the interest due and that does not include any principal. The interest not paid gets added back to the mortgage each month, a process called negative amortization, and actually increases the amount owed. When the loan increases to 125 percent of the original amount borrowed, the loan is "re-cast" and full interest and principal payments are due, often resulting in "payment shock" — a dramatic increase in monthly payments.

The available industry estimates show that Option ARMS have soared in popularity, accounting for as little as 0.05 percent of mortgages in 2003 but at least 12.3 percent of all mortgages through May of this year. In the high-priced coastal areas, Option ARMS are estimated to make up 25 percent to 50 percent of all mortgages. According to Fitch Ratings, up to 80 percent of Option ARM borrowers make only the minimum payment each month.

A New Warning Over Option ARMs

The concern over this situation has recently prompted the Federal Reserve, working with a number of federal banking agencies, to issue the special publication, "Interest-Only Mortgage Payments and Payment Option ARMS — Are They For You?" warning of the risks consumers may face and urging them to be realistic about whether they can handle the inevitable payment increases these "nontraditional' mortgages dish out. This new publication can be found at the Fed's Web site, under "Consumer Information."

An Opportunity for Some

In some areas where rising mortgage defaults are reported, about one-in-five of these homeowners lose their homes to foreclosure. Foreclosure.com says the number of properties listed on the site is on the rise, with foreclosure listings at more than 120,000, pre-foreclosures at more than 255,000 and bankruptcies at more than 386,000.

But for some, especially real estate investors, this creates more opportunities. Bolstered by the many home-flipping shows that dot the TV landscape, the increase in foreclosures has spawned increased interest in making money, by scooping up properties at foreclosure auctions at 20 to 30 percent discounts from the current market value, then renovating and selling them at a higher price.

Options for Borrowers with Option ARMs

Most home buyers should never use an Option ARM, but if you have one, you need to know the risks and how to protect yourself. Here are a few tips:

Pick A Payment Wisely: As tempting as it may be, avoid paying the minimum monthly payment. At a minimum, pay all of the interest due. Also, read the terms of the mortgage carefully so that you understand when your mortgage will "negatively amortize" and when your mortgage can be "re-cast," which would result in a higher payment.

Call Lender Before Payments Are Late: If you know you can't make timely payments when your ARM payment increases, don't wait until after you've missed a few payments to discuss your situation with your lender. Instead, talk to your bank or mortgage company before things get out of control. Your lender is interested in keeping loans from going into foreclosure and may be able to work out a deal with you. For example, it may offer a three-month grace period during which the payments are added to the loan balance, or it may offer to modify your loan by locking in an interest rate.

Refinance To Fixed Rate Mortgage: For many with Option ARMs, it may be better to refinance to a fixed rate mortgage in which the payment will be higher but never changes, rather than continuing with an Option ARM and dealing with the inevitable shock of a payment that is even higher. But carefully check the current mortgage for additional fees that may apply during a pre-payment period, which could be up to three percentage points of the mortgage amount. Also, there are closing costs to pay when refinancing a mortgage. If you do refinance, ask your new lender about streamlined refinancing, in which the new lender can use the paperwork, appraisals and documents from your prior mortgage to reduce the closing fees.

Consider Refinancing Alternatives: Some mortgage lenders, seeing their customers with ARMs leaving to other lenders who offer fixed rate mortgages, are offering alternatives such as loan modifications, in which the lender offers to change your current mortgage from an ARM to a fixed-rate loan for a fee of a few hundred dollars. While the interest rate might be slightly higher than what you could get if you shopped around for a new mortgage, the savings in closing costs can make up for this.

Cancel Unnecessary Fees: If you originally made a down payment of less than 20 percent, then you are probably paying Private Mortgage Insurance, or PMI, with every monthly payment. If you live in an area where home values have appreciated since your took out the mortgage loan, it may be worth looking into canceling the additional PMI. If your homes value is such that your current mortgage balance is only 80 percent or less of the value of the home, then you might qualify. Your lender may require you to get a re-appraisal of your home, which may cost you a few hundred dollars, but that could save you a few hundred dollars a month by canceling the PMI.