How to Lose Your House
by Steve Leung | Contact Steve Leung w/ Questions
Between the speculation and pricing madness during real estate booms, people actually buy houses so they can live long, happy lives there.
But home buyers should know — particularly if one of your goals in buying a house is achieving a more stable lifestyle for yourself and your family — that losing a house is a fairly easy thing to do. Here are five common ways people lose their houses.
1. Start Off With Bad Mortgage Terms
Most people focus on the price they pay when they buy a house, but the reality is that the most expensive part of buying a house is the interest on the mortgage. Even a fraction of a percentage makes a big difference on your monthly payments, and could mean tens of thousands of dollars over the life of the loan.
But just as it's easy to focus on the price of the house, it's also easy to get caught up with the interest rate on the mortgage. The terms of the loan are what really determine how much your mortgage ends up costing you.
The interest rate isn't the rate you pay; it's one of many charges that get rolled into your Annual Percentage Rate (APR), the actual rate you pay per year. The APR will almost always be higher than your interest rate because of added fees.
Your lender is required by the Truth-in-Lending Act to breakdown the fees and tell you what the APR is. Please don't ignore the Truth-in-Lending disclosure — you do so at your peril.
Key phrases you should ask about that signal potentially dangerous mortgage terms include: pre-payment penalty, partial amortization, negative amortization, option ARM, and sub-prime.
Phrases that signal mortgages that require extra care include: teaser rate, adjustable rate mortgage (ARM as opposed to option ARM) and interest-only payments. These are not inherently bad, but require vigilance because the rate you locked-in will change, and possibly increase significantly.
2. "Keeping Up With The Joneses"
Sometimes people who live in expensive neighborhoods and have fancy cars aren't the ones with the most money — they're just the ones who spend the most. This material arms race has caused more than one person to become so riddled with debt that they hurt the successful lifestyle they were originally trying to achieve.
Buying too big a house is a fast way of digging yourself into unmaintainable debt and causing unnecessary stress on you and your family. Financial strain leads to emotional strain and large houses often require a lot of furniture, all of which has to match the level of the house. This leads to expensive credit card debt, which hurts your ability to pay your mortgage debt.
And, also, while some people are tempted to buy a more expensive house than they need because of a good school district, you may be able to save money by getting a home in a less expensive neighborhood and sending your kids to quality private schools.
3. Failing to Communicate with Your Lenders
Even if you have fallen into a bad situation and cannot pay your mortgage, you still have the opportunity to save your house. According to John Karevoll of DataQuick, only 10% of Bay Area homeowners lose their homes in a foreclosure sale after a Notice of Default (i.e. after mortgage payments have been missed). Most make other arrangements.
But you can't make those arrangements if you don't tell your lender what's going on. Maybe you've had unforeseen circumstances at your job or have had large medical payments recently. Or maybe you're having trouble making your payments because of too much debt.
While lenders might not be described as "understanding," you can negotiate with them by understanding their goals. Lenders aren't in the business of buying and selling real estate. If they foreclose on your property, they will probably lose money on the deal and go through a lot of inconvenience as a bonus.
Knowing this and assuming you are dealing in good faith, your lender may offer you debt consolidation, a deferred payment plan, or another solution to avoid a larger loss for them.
If you run into a situation where you cannot pay your mortgage, for any reason, do not abandon the house: read The Department of Housing and Urban Development (HUD) advice on the topic, tell your lender immediately, and enlist the advice of a reputable, non-profit credit counseling service. Using a non-profit is organization is key because you run a very high risk of being scammed at this stage.
4. Mess With the Government and Its Money
There's probably no more efficient way to lose your house than to fail to pay your property taxes. The government doesn't kid around and they make sure your debt to the government takes precedence over any other debt you have. If you cannot pay your property taxes, you need to notify the government immediately.
Even if you think the tax bill is incorrect, The Los Angeles Times advises "Pay Property Taxes First, Dispute Later." Separately, the San Jose Mercury News suggests keeping an impound account as a discipline to help you save money for taxes and insurance. The bottom line is that as serious as lenders may seem about getting their money, the government will almost always get its way first.
5. Buy Too Little Insurance
Nothing causes dire financial consequences like the unexpected. Fortunately, insurance companies make their living off preparing for unexpected financial consequences. The challenge is that insurance is one of those services people don't want to think about because they don't want to have to use it — which defeats its purpose. After all, it's insurance.
But if you have a fire, or a burglary, or a flood, or an earthquake, and you are on the high-end of your debt-to-income ratio, you run the great risk of losing your house altogether because of the financial ramifications.
Some lenders will require you to get homeowners insurance but, often, standard insurance does not cover acts of God like floods and earthquakes. Moreover, while most policies cover your personal property (like your furniture, etc.), you need to take a strong home inventory including detailed lists and pictures, then store that inventory in a safe place or remote location.
(c) Steve Leung
Related Reading:
- California Mortgage Defaults Hit 8-Year High
- When Not to Buy a House
- Existing Home Sales Across U.S. Plummet: Silicon Valley Take
- Your #1 Defense Against Getting Ripped-Off on a Mortgage
- How Much House Can I Afford? (Part 1 of 2)
- How Much House Can I Afford? (Part 2 of 2)
- Subscribe to Our Silicon Valley Real Estate Newsletter
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February 05, 2007 | Filed under: Bay Area Real Estate, Mortgages, Home Buyers, Silicon Valley News
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That should be required reading before a first time home owner can close on their home. Perhaps, if it had been here in Indianapolis, we wouldn’t have had over 1,000 new bankruptcies and 1,000 new foreclosures every month. Our problems are not completely the buyers faults, but have been due to the fraudulent actions of appraisers, mortgage brokers, and realtors all over the city. We had 8 appraisers go to federal prison last year alone.
Anyways, great post.
This is why it is imperative, especially for first time home buyers, to work with an agent whose objective is to protect the buyer’s interests. In my book the commission always comes second. True consultants earn their living by giving honest advice and not by setting clients up for failure. The people who put commissions first are not in for the long-haul and are usually out of business within a very short time. So, do your due diligence and trust your gut when you choose your agent or consultant.
Good article, and a must read for the novice home buyer. While the buyer is supposed to be informed about all the nuances of the mortgage contract, it may not be covered completely, or the buyers may feel reluctant to ask for clarifications. It is imperative to know and understand what you are signing up for- your house and future could depend upon it. Having a knowledgeable and honest realtor is a first step in ensuring your success in this experience.
Thanks for the article! I’m currently in the market to buy my first home and the info you just provided helps a lot! I never realized the difference between the interest rate and APR.
Cheers,
-RY