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The Mortgage Market is Broken

By: Richard Feldman

By: Richard Feldman, CFP, MBA, AIF

Individuals and families have found out how important it is to pick the right financing option for their primary residence. The sub-prime mortgage shakeout and credit contagion has cost us one investment bank (Bear Stearns) and another that is severely wounded (Lehman Brothers) and left us with millions of Americans who have lost or are on the brink of losing their homes.

Most individuals do not consult a professional before they make the biggest decision of their financial lives which is obtaining a mortgage. The current mortgage market does little in offering borrowers proper advice on how to structure the biggest purchase they will ever make. Instead, borrowers are forced to deal in a system that is ripe with self serving interests and wrought with conflicts. There is little oversight of the mortgage industry and its professionals. Most mortgage industry professionals have no certification in providing advice to individuals on how to structure their home purchase.

FICO Score

FICO is a credit score developed by the Fair Isaac Corporation. A credit score is a numerical expression based on a statistical analysis of a person’s credit files to represent the creditworthiness of that person, which is the perceived likelihood that the person will pay debts in a timely manner. A credit score is primarily based on credit report information, typically sourced from credit bureaus / credit reference agencies.

Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. Lenders use credit scores to determine who qualifies for a loan, at what interest rate, and with what credit limits. The use of credit or identity scoring prior to authorizing access or granting credit is an important step in the implementation of a trusted system.

Credit scoring is not limited to banks. Other organizations, such as mobile phone companies, insurance companies, employers, and government departments employ the same practices. Credit scoring also has a lot of overlap with data mining, which uses many similar techniques.[1]

Mortgage Market

Individuals with option adjustable rate mortgages (ARMs) that are resetting in the next few months have fewer and fewer options. With interest rates trending upward and the jumbo mortgage market virtually locked, there are fewer options available for home owners. Government programs are beginning to build up steam and provide an option for homeowners who are headed into default. Lenders are also beginning to realize that reworking a current loan is better than having that loan go into default but the process has been slow to catch on.

There are, however, still a lot of people out there that could benefit from refinancing now and moving into longer term loans such as a 30 year fixed. Paying the upfront costs to refinance into a longer term loan is well worth the security of knowing your payments will not fluctuate for the next thirty years. Most bankers charge approximately three to five percent of principal in closing costs to refinance a loan (This includes attorney fees and title searches).

Qualifying to refinance becomes even harder if you purchased your home in the last few years of the run in the real estate market (2005, 2006, and 2007). Homeowners who put little equity down on their home can now find themselves in a situation where they could be upside down on the property (owing more than the house is worth).

Refinancing

Your payment Interest rates are still low in comparison to long term historical rates. Individuals with good credit can still look to refinance into a 30 year fixed term loan at around 6.5%. If you were to borrow $400,000 on a 30 year basis at 6.5% your payment terms would be the following:

is $2,528.27 for 30 years with a rate of 6.500%.

Mortgage Summary
Loan amount $400,000.00
Term 30 years
Interest rate 6.500%
Monthly payment $2,528.27
Total payments $910,179.81
Total interest $510,179.81

Summary

Federal Chairman Alan Greenspan is on record saying that individuals may be overpaying for the security of long term fixed rate loans. I am sure that most people with adjustable rate mortgages would have been more than willing to pay a little more for the security of knowing that they could afford their monthly mortgage payment and not risk the chance of having their house go into foreclosure.

Unfortunately, most individuals relied on advice that was designed to get the deal done. Bankers designed loan products that allowed individuals to stretch beyond their means. Now with all of the resets going on in the option market, home owners soon realize that they cannot afford the additional payments.

A primary residence is typically one of the largest purchases in an individual’s life. Make sure that you are aware of your financing options and how they can affect you on a long term basis.