Given the dire news emanating from the mortgage and real estate markets these days, setting out to purchase your first home can inspire a great deal of anxiety. With so many headlines about predatory lending and record high foreclosures, many young families are steering clear of the mortgage market, afraid of becoming a statistic. However, a consumer who takes the time to become knowledgeable about the basics of responsible mortgage lending practices has no need to fear the home loan market. Armed with good information, consumers entering the market for the first time can avoid the pitfalls that have been the ruin of many less diligent home buyers.
The foreclosure crisis began in the sub-prime home loan market, largely due to poor decision making on the parts of both lenders and consumers. The housing bubble, with its inflated home prices, encouraged both groups to be somewhat reckless, to gamble on a continued rise in home prices. Loans were made to a great many consumers that were beyond their means, creating a situation that depended upon rising home equity and low interest rates to ensure that these loans would remain affordable.
However, as the housing bubble began to deflate, the situation changed dramatically, with home values that had been rising at record rates, a full 80 percent between 1995 and 2006, beginning a decent that would set records as well. Rising interest rates meant steeply climbing payments for many borrowers, as those teaser rates expired and adjustable rate mortgages reset to market rates. Those that bought homes at inflated prices found themselves owing more on these homes than they were worth as home values began to adjust to a more realistic level, making refinancing out of those expensive loans difficult. Foreclosure rates among this group soared, adding to the downward pressure on home prices.
A significant number of the consumers who have been part of the wave of foreclosures were not fully aware of the risk they undertook as they signed these home loan contracts. Many fell victim to their own ignorance of the mortgage process as they allowed aggressive mortgage brokers or lenders to steer them into loans that were not in their best interests. Many more of these ill-informed consumers will pay the price in the near future, as $250 billion worth of adjustable rate mortgages are due to reset in 2008 and 2009.
For those who heed the warnings implicit in the misfortune of these consumers, today's market contains a great deal of promise. With home inventories on the rise and prices dropping dramatically in many desirable areas, a smart home buyer could do quite well in the current climate, purchasing a solid family home for a very reasonable price. With careful comparison of the available home loan products, consumers can find many secure and sensible options to finance the purchase of a new home.
While most mortgage brokers and lenders are honest, a certain number of them will take advantage of the unwary or inexperienced consumer. Learning the common tactics used by such characters can help you to recognize predatory lending practices before you become a victim, helping you to ensure that the loan you settle on for your new home will be to your best financial advantage.
Excessive fees are among the warning signs to watch for, generally buried in the fine print of a home loan. While most mortgages carry some fees, they usually will be confined to a total that is less than 1 percent of the loan amount in a competitive loan product. Predatory loans often carry fees that total five percent of the total loan amount or more, and are typically financed into the loan to avoid the notice of the consumer who does not read the fine print, rather than paid upfront.
High prepayment penalties are a factor to be leery of when shopping for your home loan. Dishonest loan originators will often fail to mention that a loan carries these fees, which are charged to the consumer who pays off their mortgage early, causing an unpleasant surprise for consumers when they try to refinance out of that expensive loan into a more reasonable option. While many sub-prime loan products carry prepayment penalties, and a few in the prime market do, generally these are in effect for three years or less. Abusive prepayment penalties are in effect for three years or more, sometimes throughout the entire loan term.
A mortgage broker or lender that approaches you with a loan offer that is unsolicited should raise suspicion in your mind. This is a common tactic among unscrupulous lenders, often found in the reports of predatory lending legal cases. Reputable mortgage lenders are not in the business of soliciting randomly for new clients by phone or direct mail advertisements. These tactics are generally used by less reliable or even fraudulent organizations who purchase "lead lists." This can happen after you have made inquiries with legitimate banks or mortgage lenders, many of whom sell consumer information to third parties.
Inflated property appraisal is another tactic favored by predatory lenders, allowing them to sell homes to unwary consumers for much more than their true market value, increasing the loan amount to inflate their profits. Again, borrowers who do their homework before purchasing are much less vulnerable to such tactics. An appraisal done by an assessor chosen by the borrower is a sure way to avoid paying too much for your home. Comparing the appraised value to comparable homes in the area is also a good way to protect against such abuse.
Borrowers should be aware of their credit standing before approaching a lender or broker. By knowing their credit scores before engaging in the loan application process, consumers can avoid another popular tactic of shady loan originators, which is steering borrowers into more expensive sub-prime loans when they are well qualified for less costly prime level products. Statistics show that nearly half of sub-prime borrowers could have been qualified for less costly loans than they received.
Exotic sub-prime loans can be very dangerous ground for the inexperienced financial consumer, particularly those of moderate or lower income. While many of these loans can be very advantageous to those who understand them clearly, those who don't can find themselves in serious financial trouble over time.
Interest only loans can be quite attractive to borrowers, offering an affordable payment initially, but rising, often steeply, when the interest only period is over and the payments adjust to include installments on the loan principal. Uninformed mortgage consumers may not fully comprehend the rate at which their monthly payments can soar when these loans adjust, nor do they realize that these loans can, in some circumstances, leave them owing more on their loan principle after several years of payments than the balance they began with.
Balloon loans can create a similar issue for the inexperienced consumer. Relatively low payments over a certain number of years can make them attractive, but at the end of that period, the total balance due on the loan must be paid. Refinancing is often the way this is handled, but those with shaky credit or little home equity can find this solution difficult, a detail that less scrupulous originators may not disclose.
Piggy back loans are another exotic loan product that must be approached with care. These loans are designed to allow consumers to obtain their home with little or no down payment, or allow them to borrow more than they might qualify for with a traditional mortgage loan. These loans are constructed by originating a primary loan for 80 percent of the purchase price, and a second mortgage for the remaining 20 percent. Many consumers who have used these loans have found that they bought homes beyond their means, running into serious financial trouble over time.
Tax sales and foreclosure properties are another area in which the first time home buyer should beware. While there are often bargains to be found in this market, the process to take advantage of them can be quite complex. Consumers inexperienced with the process can often find themselves mired in a financial and legal mess, despite the promises of quick and easy riches with foreclosure homes on those 2 AM infomercials.
With the current chaos in the housing and mortgage markets, the need to be well educated in the basics of the home loan industry before beginning the process has been clearly illustrated. While many consumers have shied away from the housing market in recent days, a clear understanding of the purchasing process can provide effective protection for the average person against the issues that have plagued the market in recent days. A consumer who does some research into a variety of mortgage products can make well-informed choices when borrowing for that new home, ensuring that the loan chosen to finance it will remain affordable through the years to come. For such a consumer, today's dropping home prices and rising market inventory can provide a beautiful new home at a reasonable price.
