How to defuse a ticking home loan

By Liz Pulliam Weston

The young woman just wasn't getting it.

She called Consumer Credit Counseling Service of Nevada and Utah for help managing her family's mortgage payments. A year ago, a mortgage broker had persuaded her to refinance the family home, pull out all of the equity and invest the cash in a rental property. Now both mortgage payments had reset to much higher levels, with the interest rate on the rental jumping from 1% to more than 8%.

She couldn't afford either payment. Michele Johnson, the CEO of the counseling service, remembers the woman pressing for a way to keep her home, but there wasn't one. The problems were that:

• Both properties had lost value as Las Vegas' real-estate bubble popped. The woman owed more on the homes than they were worth, so lenders wouldn't refinance the loans.

• So-called rescue funds, set up by some states and some lenders to help victims of predatory lending, had far more applicants than funds, and they weren't available in her case anyway.

• A bankruptcy filing, touted by attorneys in television ads as a way to "fight foreclosure," would just put off the inevitable.

The woman's only option for avoiding foreclosure was a short sale, in which she might persuade a lender to accept the sale proceeds from both properties and forgive the rest of her debt. But, Johnson said, the woman didn't want to hear that.

"People have this unrealistic viewpoint that 'this is my home; I'm not going to lose it.' It all becomes very emotional," Johnson said. "Listening to facts and figures is not what they want to hear. They want a rescue."

Don't delay

If your loan is part of the huge wave of mortgages that have seen payment increases in the last two yearss, ignorance and denial are not your friends. You need to take action, and the sooner the better:

• If you've still got some equity in your home and the ability to handle a larger payment, you may be able to switch to a smarter loan.

• If your situation isn't as rosy, quick action can contain the damage to your personal finances.

Here's your game plan.

Know where you stand. If you took out an adjustable-rate mortgage and your rates haven't reset yet, dust off your mortgage documents, advises LendingTree.com chief economist Jim Svinth, and scour them for important information, such as:

• When your payment is scheduled to adjust.

• What benchmark the payment will be based upon (such as the LIBOR rate or the one-year Treasury).

• What your margin is (this is what is added to the benchmark to determine your new rate).

• What your caps are (many adjustable loans typically can increase no more than 2 percentage points in a year and 6 percentage points over the life of the loan, but check your documents to be sure).

You can find the most recent benchmark rates at HSH Associates' ARM index page. Once you know what your new interest rate is likely to be, you can use HSH's amortization calculator to determine what your new payment would be.

Math-challenged? You may be able to simply call and ask your lender or loan servicer, if they're not too busy handling all the folks who have already defaulted.

You also need to find out whether you would face a prepayment penalty for refinancing your loan. Prepayment penalties are unfortunately common on loans extended to people with troubled credit, and until they expire, they can make a refinance harder to justify financially.

Your future is tied to your past

Get your credit reports and FICO credit scores. Your options will be dictated in large part by those scores, said credit and mortgage expert Gerri Detweiler of FreeRateSearch.com, particularly if you don't have much equity in your home or can't document your income with tax returns or other proof. You generally need a score of 700 or better to get the best rates and terms. If your scores are 660 or below, LendingTree.com's Svinth said, you'll face more scrutiny from lenders and have a tougher time getting a loan.

This is a big turnaround from years past, Svinth said, when lenders were falling over themselves to give no-down-payment and no-equity loans to borrowers with credit scores below 620 and income they couldn't or wouldn't prove.

"We've gotten back to basics," Svinth said. "Credit and collateral matter now."

Continued: Check your credit scores

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