Fancy mortgages can be trap
Author warns about flex-pay, interest-only
Cox News Service
September 11, 2005
ATLANTA — Credit cards are traditional tools for digging yourself into a morass of debt.
Now you can take the same disastrous route with mortgages, and more people are managing to do it, says debt guru Liz Pulliam Weston.
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"Some of the folks I'm seeing buying houses now are already stretched to the limit," she said. "They're adding on this big, scary mortgage on top of it. I'm not sure they have the resources or the sophistication to know what they're getting into."
She digs into the topic in a new book, "Deal With Your Debt," scheduled for publication Wednesday. Weston spoke about the risks in an interview last week. Q: Tell us about interest-only mortgages.
A: These have been around since the 1920s. They were very popular then, because people wanted to take their extra cash and put it into the stock market. You know how that party ended.
But in the last few decades, these mortgages have been sold by the major mortgage companies. Now they are being used in a lot of very expensive mortgages to get people into houses that they otherwise couldn't afford. That's not what these mortgages were created for, and it's a very dangerous way to buy a house.
I would say, if you're considering one of these interest-only mortgages, go through all the math. See how high your payment could go. If you feel comfortable with how high the payment can go, then you probably are the kind of person these were intended for.
For example, one of the classic cases [for whom the loan works] was somebody who had a fairly high salary but then got big bonuses at the end of the year. A Wall Street investment guy or something like that. But I'm not as worried about those folks as about people who are earning a salary and barely making payments. If the interest rate changes, or if they have to start paying back the principal, they are sunk.
Q: Spell it out for us: Why are interest-only mortgages so dangerous?
A: Because you're only paying the interest on the loan. It may be for a period of five or 10 years, but eventually you are going to have to start paying back that principal. The payback period is shorter.
Another issue is that you're not really locking in an interest rate for the life of the loan. It's typically locked in for a year or five years, something like that. Then it can go adjustable, so you're exposed to interest rate fluctuations.
A ton of people just assume they'll refinance down the road. But you can't guarantee that interest rates will be lower down the road, or even the same. Interest rates could be a lot higher. These are risky mortgages, and people really need to understand the risks before they get into them.
Q: Do you foresee a lot of people getting into trouble, even into bankruptcy?
A: I think so. I think we're getting to the point that these are really being oversold to people who shouldn't be in them. The mortgage professionals need to keep the business going. I think they are overselling them. I don't think they're telling people about the disadvantages, or the disadvantages aren't sinking in.
I can easily foresee a lot of situations where you have a substantial jump in interest rates or even if the housing market slows down and suddenly you can't sell your house for what your mortgage is worth. Then I see people being in trouble.
Q: How about flex-pay mortgages?
A: One of your options is that you make a payment so small that it doesn't even cover the interest. Don't even think about the principal, you're not even covering the interest that's due. That unpaid interest is added onto the principal. It's called negative amortization. You can be paying a mortgage for years, and your mortgage could just get bigger.
The statistics I'm seeing from the banks and the lenders that are pushing these suggest that a lot of borrowers are doing exactly that. They are not paying enough to cover their interest, and their loan sizes are growing.
I think these folks are in even more trouble than the interest-only folks. They're in a situation where even a small downtick in home prices will leave them underwater, if they're not underwater already. That is, they owe more on their mortgage than their house is worth.
Q: What do people need to do to protect themselves from getting into credit problems?
A: Here's a very basic tactic: Don't charge more than you can pay off in a month. That's something my mama taught me, and it has come in so handy throughout my life.
This does two things. One is that it protects you from all the credit card company tricks. It keeps you from having to pay interest, to start with. But also, they can't mess with you the same way if you don't carry a balance. They can't change your due date and rack up late fees and over-limit fees and all these other fees they have. You're protecting yourself as a consumer by not carrying a balance.
The second thing is that you have that available credit if you need it in an emergency. Think about all those refugees from Hurricane Katrina who don't have an emergency fund and who no longer have a job. The folks who have access to credit will be able to tide themselves over for a few months, until they get that next job and figure out where they're going to live.
Folks who don't have that are in a tough situation.
Q: If you're already in trouble, what do you do now?
A: There are a lot of things. Obviously, the first thing you do is look for anyplace you can cut corners, cut your expenses so you can free up more money to pay off those credit card debts.
Then look at the money you've freed up and say, "If I stop charging today, can I get this debt paid off in three to five years?"
If you can't, then step two is to go to a legitimate credit counseling service, one that's accredited with the National Foundation for Credit Counseling, www.nfcc.org. If they can help you, great. If they can't, then bankruptcy is probably your best option.
But if you can pay it off in three to five years, then go for it. There's no sense in filing for bankruptcy if you don't have to.
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