Hindsight is 20/20. We can look back upon what transpired in the real estate market over the last several years – from boom to bust – and recognize problems that were in the making. Lenders have attracted a fair amount of criticism due to the mortgage products they offered to homebuyers. But some of the responsibility lies on the shoulders of the buyers themselves. They made mistakes by agreeing to terms that were less ideal than they appeared. Trouble followed, evidenced by a surge of foreclosures.
Below, we’ll present some of the most common mistakes made during the most recent upheaval in the real estate market. On their surface, each of the following blunders may still seem attractive. But we now know the problems they can introduce.
Extending The Length Of The Mortgage Loan
For over a generation, the 30-year mortgage was a mainstay of the market. There was no need to mention the term of your loan to others. Unless otherwise mentioned, it was assumed to be over a 30-year period.
Times change. Years ago, mortgage lenders began to extend 40-year loans. The advantage, as presented by lenders, was that borrowers could make lower monthly payments than would otherwise be the case with a 30-year loan. But there were also a few drawbacks.
First, the interest rate is usually higher. Second, the borrower spends more time paying interest on the loan, and thus takes longer to start paying down the principal. As a result, it takes much longer to build equity. Third, if you take on a 40-year loan in your thirties, you would presumably be making mortgage payments in your seventies.
Buying Without Making A Down Payment
Few mortgage options are as strongly correlated to the subprime debacle as loans that did not require the borrower to make a down payment. From the borrower’s perspective, this feature was attractive. It allowed her to purchase a home, even if she lacked any type of savings. From the lender’s point of view, a current source of income was sufficient evidence of the borrower’s ability to make timely payments.
The problem with these loans is that homebuyers were more likely to walk away from them. If they were unable to make payments, or the value of their homes dropped below the amounts owed on their mortgages, they were liable to abandon their properties. Looking back, this is exactly what occurred.
Allowing The Interest Rate To Fluctuate
Adjustable rate mortgages (called ARMs) have been around since 1982. This was the year the Garn-St. Germain Depository Institutions Act was pass by Congress, giving lenders the flexibility to offer ARMs to borrowers. On the surface, an adjustable rate seems to be an appealing option. The borrower enjoys a lower interest rate for the first few years, after which the rate is bumped to a higher level. At that point, the homeowner can refinance to bring the rate back down.
As we’ve seen over the past few years, being able to refinance a mortgage loan is not a foregone conclusion. Many homeowners have tried to do so, and been turned away by their banks. Why? Because plummeting home values have eroded banks’ confidence in borrowers’ ability to make payments. The result is that homeowners are stuck with larger monthly payments based on a rate that is much higher than originally intended.
Venturing Off The Beaten Path
Mortgage loans were once straightforward. A homeowner would make monthly payments based on a clearly-defined amortization of her loan’s outstanding balance. Things have changed. Lenders now offer more creative “solutions” for buying a home. For example, borrowers over the past several years have been able to purchase homes while paying nothing more than the interest on their mortgage loans.
This translated into lower monthly payments, which prompted consumers to buy houses that were valued higher than they could realistically afford. Down the road, lump sum payments were required, forcing many homeowners into foreclosure.
There are attractive homes for sale in nearly every geographic market. If you’re currently thinking about buying a home, be wary of the mortgage-related mistakes others have made in the recent past.