August 28, 1998

125% loans getting people in trouble

By TOM KELLY
The Real Estate Advisor

How, you ask, can interest rates be new record lows and federal bankruptcies at record highs?

The bottom line is that consumers are borrowing like crazy - often for the wrong reasons. According to a recent report by the Administrative office of the United States Courts, personal bankruptcies were up an astonishing 9.2 percent over last year. That's an astonishing statistic given the fact that consumers have traditionally used a low interest rate environment to get out - not in - to debt.

One piece of the puzzle is that bankruptcies are up because new legislation is on the table to make it more difficult to cure debt simply by filing for bankruptcy protection. The bitterly ironic truth is that the legislation was pushed by credit-card companies - the same folks that deluge us with instant credit cards in the mail, enticing us to borrow even more money on plastic. My main concern is how far lenders are willing to go to extend cash to consumers. After all, property foreclosures also are up significantly. What if interest rates zoom skyward to the levels we experienced just over a decade ago? Will a new wave of defaults be washed ashore?

Some lenders say debt problems will rise before rates do. While some studies have predicted that bankruptcies will level off later this year and decline in 1999, the type of "new" borrower as not necessarily considered.

"I think this is just the tip of the iceberg," said Ed Laine, regional director for Investors Mortgage Company, a lender specializing in higher risk customers and loans. "Some of companies first offering the 125 percent loans got customers who needed relatively small amounts of money for a short period of time. Now, other companies have tried to get their market share and the quality of borrower has declined."

It seems to me that lenders are continuing to look for a new product to stimulate the market. There is nothing wrong with that - it's what competition is all about. But the creative writing that went into adjustable-rate mortgage loans is one of the primary reasons the national foreclosure rate is so high. Heavily discounted ARMs, which never really surfaced in this area, gave those mortgages a bad reputation and now the 125 percent craze appears to doing the same thing on a more deliberate level.

"We will not write those 125 percent loans," Laine said. "We have been approved to do so for the past 18 months but I don't think they are good for most people. In fact, I've even heard of 135 percent and 150 percent loans that are out there.

"Often, we will solve a borrower's problem by refinancing and paying off the credit cards. Some of them just go back to borrowing on the credit card. Can you imagine doing that and having a 125 percent loan?"

The problem with some of the loans offered today is that many of them - especially the ones offering to lend you 125 percent of the value of your home by simply making a phone call - can carry interest rates as high as your credit card. Although home equity interest rates depend up your overall loan- to-value ratio, be leery of any home equity rate greater than 9.75 percent.

And, any amount greater than the value of your home will not be tax deductible.

Borrowers might find it surprising that lenders don't really care how much money is loaned. That's because it is not the lenders' job to monitor what is deductible mortgage interest and what is not. It will be up to the Internal Revenue Service to oversee this new influx of cash. The only way the IRS is going to be able to check on who's doing what is obtain the original papers on the house, plus the bills on an additions.

I am all for options - especially new niches that might help consumers find a place to live or solve a financial disaster. But the consumer cannot to skip self-help information in regard to credit cards and home equity. Any loan must be viewed in the context of overall financial planning.

It should never be used for frivolous, unplanned spending - like a series of seemingly harmless credit-card charges.

Previous columns:

• Renting your home out for 14 days can be lucrative, 08-06-1998
• Real estate bargains in Canada not so easy to realize, 07-31-1998
• 'Cozy' or cramped: Who's to blame when real estate ads fib?, 07-24-1998
• Homeadvisor: tool for agents or new market for Microsoft to dominate?, 07-10-1998
• Homes of the stars: sales bring more lookers, not offers, 06-26-1998
• Times at the lake bring back memories, 06-19-1998
• Costco home sale referral network is restructured, 06-12-1998
• Raffling a house is a chancy move, 05-29-1998