Honey…the Bank is on the Phone…since We Were Two Days Late on our Payment

There is just too much at stake for the lender and the borrower. Being proactive is the rule of the day. In the area of Adjustable Rate Mortgages, lenders are pre-empting “payment shock” by calling months ahead to determine the budget status of families looking down the barrel of a huge increase. Some lenders who are able through this intervention to obtain the whole story that will allow for skipping a payment called a forbearance process where the arrears are made up in smaller parallel payments while continuing on with the regular payment. Lenders are hedging their bets by getting involved in the non-payment or late payment profile process early on to dampen losses resulting from foreclosure.

Three years ago Aaron and Gwendolyn moved from sharing an apartment to marriage to having a set of twins to buying their first home. Aaron four years out of college was employed at a local engineering firm specializing in water treatment and sewer/water construction work for several cities and counties in a 60-mile radius. Aaron started at an entry-level engineering position and was working his way up project by project. He was working to passing exams and satisfying requirements to become a Professional Engineer and thus command more money. The pay increases due to a slowing workload were lagging what was projected. Gwendolyn is a Registered Nurse worked a flexible schedule of three twelve-hour shifts per week and since she worked from six in the evening to six in the morning they were able to avoid any outside childcare. This gave her plenty of time with the twins who were experiencing the terrible twos period of pleasantry.

When Aaron and Gwendolyn bought their home due to cash flow considerations they chose an Adjustable Rate Mortgage with a start rate of 1.5%. With a purchase price of $325,000.00 the couple was able to negotiate an 80/15 piggyback combo with a combined loan to value of 95% CLTV. The first mortgage of $325,000 x 80% = $260,000.00. The second mortgage of 15% amounted to $325,000 x 15% = $48,750.00. The payment on the first was based on 1.5% so the payment for the first year was $897.31/month. The payment was scheduled to go up 7.5% per year for the first five years UNLESS the negative amortization exceeded 115% of the original balance, which would trigger amortizing the whole mortgage balance at the fully indexed rate. It is now winding up the end of the third year going into the fourth. The first year minimum payment was $897.31/month. The second year increased 7.5% to $946.61/month. The third year increased to $1,036.96/month. At the beginning of the month a noted rate increase was received. In reviewing, the prior month’s payment was $1,036.96/month. In the meantime, because the second mortgage was going behind a negative amortization first mortgage the best second mortgage available was one that is tied to the prime rate. Currently the prime is at 8.25%. Due to the risk level an additional 1.50% margin is added to the prime rate giving a current rate of 8.25% plus 1.50% = 9.75% rate on the second mortgage. The payment is now $415/month on the second mortgage but will float with prime. All during this period the taxes have risen to $3,900/year for a monthly escrow of $325/month. The hazard insurance has been holding with slight increases to $2,900/year = $241.66/month. The prior month’s payment was $1,036.96/month plus $415/month on the second mortgage plus $325/month in taxes and $241.66/month in hazard insurance for a total housing payment of $2,018.62/month. This was stretching the budget but Aaron and Gwendolyn were just making it together with all the expenses of the twins and settling in to a new home.

Now with the most recent notice it brought home the downside of a negative adjustable rate mortgage showing its teeth from the ARM disclosure. There was a mountain of paperwork to sign at the closing outlining what was to transpire in the course of time with regard to this particular negotiated mortgage deal. The mortgage broker chose to present a 3.75% margin on top of the one-month LIBOR index, which is now at 5.32%. So the current fully indexed rate is at 5.32% plus 3.75% margin for a rate of 9.07%. With the broker structuring the deal at a 3.75% margin it gave a bigger Yield Spread Premium payment from the lender to the broker at closing. Margins could have been set closer to 2.00% or 2.25% to slow down the steep increases. If the lower margins had been selected, then the fully indexed rate would have been 2.0% + 5.32% = 7.32% or 7.57%. This is a big difference. The end result was to set the borrowers up to explode payment wise in three years in a rising market. With a 115% LTV loan to value limitation the mortgage could float up to approximately $260,000 x 115% = $299,000 before full amortization would take place by recasting the payment to pay out in the remainder term.

Note: ARM rider terms can very from case to case. Many differences are based on the index selected. Acronyms such as COSI, MOSI, MTA, 1-month LIBOR, 6-month LIBOR, 1-Year Treasury, 3-Year Treasury, 5-Year Treasury, etc. populate the market place. Some are more stable while others spike up and down over time. The consumer needs to carefully select something that will work for them. Look at the history of the index and understand it. If the ARM loan is not fully understood in detail, pass and get something else. The stakes are just too high.

This month’s notice put Aaron and Gwendolyn in shock. The mortgage amount on the first was now at $299,000 and the mortgage was being recast to fully amortize at the fully indexed rate of (5.32% index + 3.75% margin) 9.07% adjusting monthly per index movement. The new payment based on $299,000 principal and 9.07% rate with a remainder term of 323 payments leads to a payment of $2,477.59/month. This was a $2,477.59 - $1,036.96 = $1,440.63/month increase in payment. This was indeed a budget destroyer.

Normally, their mortgage payment was paid on the 1st of the month within a few days, but not this time. Aaron and Gwendolyn thought about selling or just walking away. With a new first mortgage payment of $2,477.59/month + $415/month on the second + $325/month in taxes + $241.66/month for hazard insurance for a new payment of $3,459.25/month. This was just an overwhelming number to them. It was great while it lasted paying the absolute minimum and staying in the $2,000/month range, but the chickens had come home to roost.

Gwendolyn called out to Aaron, “Honey! The bank is on the phone …since we were two days late on our payment…they want to make a deal.” Aaron thought it strange with just two days off from his normal payment date the bank would be calling and pounding on him for the money. The account executive flagged the file as one experiencing a major increase in the payment. She was proposing to role the first and the second mortgage into a new loan based on a fixed rate on a 40-year term with a rate of 6.25% fixed. The bank was willing to cut closing costs in half and add them to the mortgage and waive the six-month’s interest rate penalty on the first mortgage and roll the escrows over on the new loan. Looking at the numbers the first mortgage of $299,000 was added to the payoff on the second mortgage of some $47,772.88 for a total payoff of $346,772.88 plus accrued interest and closing costs of $4,000 for a new loan amount of $350,775.00. Fortunately for Aaron and Gwendolyn their property had appreciated from $325,000 to $375,000. Using an AVM (Automated Valuation Model) the bank was satisfied with the value found online and was waiving the appraisal. This was a 95% LTV loan and the bank was going to portfolio the loan and waived the PMI insurance by eating it. The new payment based on the $350,775.00 loan was $1,991.49/month for principal and interest. With taxes and insurance the fixed rate payment was now $1,991.49 + $325/month in taxes + $241.66/month in insurance for a new proposed housing expense of $2,558.15/month. This was ($3,459.25 -$2,558.15 =) a savings of $901.10/month with a fixed rate mortgage with only increases for taxes and insurance to deal with over time.

Aaron and Gwendolyn thought about the scenario for about five seconds and took the deal. It was either accepting this deal or move. Their credit would be destroyed in the process if they chose to do something else. If they tried to sell with selling costs there would be nothing left. This credit challenge would have been difficult to overcome. It was going to be rough for a few months but as soon as Aaron got his Professional Engineer (P.E.) designation he would be making a lot more money and his stature in the engineering community would skyrocket with his civil engineering background and other positive options would be available.

With what is happening in the market place, lenders are taking hits on short sales for as much as 10% to 20% of what is owed just to get it off the books. If the lender can work out a situation and the terms are made flexible and loans are rewritten all designed to keep the owner in the home and keep the property out of foreclosure. If a property goes into foreclosure there is a good chance a lender will take a major hit so all kinds of inducements and incentives are put into play to keep the loan in a performing status. Lenders are now doing “workouts” before the situation gets dire for the borrowers. A foreclosure on a borrower’s credit is a very adverse event to overcome. In some cases some lenders will not look at applications for a year or two after establishing a new housing history. There is a great benefit to borrowers to work it out.

In this case, Aaron and Gwendolyn were able to save their homestead and reduced their mortgage to a manageable level. They agreed among themselves, to make extra payments just as soon as Aaron got his P.E. ticket and put the amortization down in the twenty-year range just to justify the big run up in negative amortization. Many other couples are not being offered options as the loan has been sold into the secondary market and the service departments may not be able to offer generous options. In that case the homeowner needs to immediately seek help to change things up before it gets totally out of hand. It will end up in the tank with credit ripped to shreds if efforts are not made to engage the lender early in the cycle. Once “Notice Of Default” is filed it will be tough. The adverse credit event will likewise show up on the borrower’s credit and further complicate things by plummeting FICO scores.

To review: IF an ARM product is the answer, then the lowest possible margin needs to be negotiated coupled with a stable index. An option ARM has the power to allow a borrower to pay above the minimum payment and insure it does not go negative. Some lenders offer a bi-weekly plan, which accelerates the payments by making an extra payment per year and reducing the negative amortization. In any case, a consumer needs to shop and enter into an ARM mortgage with full knowledge of what the terms and conditions of the deal.

Otherwise, “Honey…The Bank Is On The Phone…Since We Were Two Days Late On Our Payment…They Want To Make A Deal…” OR “If we don’t have a payment by Friday, a Notice Of Default will be filed and Foreclosure proceedings will follow.” Homeowners need to be proactive if there is an impending problem with payments they may just get a sympathetic ear.

Dale Rogers
www.brokencredit.com
www.sellerhelpsbuyer.com
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