With the new volatility in the housing market, many homeowners and buyers are wondering how the numbers will affect them. "Good Morning America" financial contributor Mellody Hobson explains how you can survive the mortgage crisis.
With the dramatic rise in the number of foreclosures as well as the related crisis in the financial markets, will it be harder to obtain a mortgage if you do not have much credit history or you do not have a strong credit rating?
Yes, on both counts. Lenders are now going to be less and less willing to take a risk on borrowers because taking those risks during the recent housing boom has now put many lenders in financial distress. So, if you are younger with very little credit history to show a lender, it may be difficult for you to obtain a mortgage. Likewise, if you have some black marks on your credit history, you may want to try to work on improving your credit score before you leap into home ownership.
So, how can you improve your credit to make you a more appealing borrower?
First, find out what lenders know about you by ordering copies of your credit report from the big three credit agencies -- Experian, Equifax and TransUnion. You are entitled to one free report from each agency per year and can access them by visiting www.annualcreditreport.com. Keep in mind, each report may contain different information as creditors are not required to report to all three agencies, so it is important to look at each report. Your credit report not only provides basic information about you, such as your name, address, date of birth and Social Security number, but it also details your outstanding debt and available credit.
If you are looking to improve your score, you first need to dispute any errors in writing. Then, one of the easiest things to do is simply pay your bills on time as your payment history makes up one-third of your credit score. Next, as you may suspect, you need to start paying down your credit card debt.
A key component to your credit score is your credit utilization, which is the ratio of debt to available credit. A low credit utilization is a good thing because it means that while you have available credit, you do not need to use it. For example, if you have credit card limits totaling $25,000 and have credit debt of $10,000, your credit utilization is 40 percent. If you can cut that debt in half to $5,000, your credit utilization lowers to 20 percent, which will be viewed more favorably. But, do not be tempted to open new accounts in an effort to tip the scales back in your favor if you have a high amount of debt. New accounts can be bad in two ways. First, they can indicate that you are in trouble and searching for more credit and second, they will lower the average age of the accounts on your credit report.
What about would-be buyers with little or no money for a down payment? Will it be difficult for them to secure a loan?
Yes, the days of easy money are over. While zero-down loans were all the rage in the hot housing market, they carry significant risk to the lender and the borrower in today's environment. If a borrower has to sell her home and the value has declined since she purchased it, she will likely sell at a loss. With no money down, even after the sale, she will still owe the lender money -- putting both the lender and the buyer in a compromising financial position. That said, with the rapid rise in foreclosures this year, it will be difficult to find a private lender willing to offer you a mortgage without a down payment of at least 5 percent -- and if your credit score is not stellar, you will probably have to pony up an even bigger amount.
In addition to lenders being more stringent about who they lend to, you say it is going to be more expensive to borrow. What impact will that have on would-be buyers?
Ultimately, higher interest rates mean higher monthly mortgage payments. So, the amount of home you could afford a few months ago will likely need to be reevaluated and lowered. The borrowers who will feel the most pain are those looking for jumbo loans -- mortgages of more than $417,000 -- as troubles with these loans have been a big contributor to the crisis in the mortgage market, making them an unappealing business proposition for many lenders at this moment in time. While rates have not shot up dramatically in the conforming mortgage market (i.e., those loans under $417,000), they have risen a bit over the past several months. And, as you will see, every little bit matters.
Mellody's Math: Last week, a homeowner with a $417,000 mortgage, on average, could have secured a jumbo 30-year fixed rate of 7.4 percent -- higher than the average 30-year fixed rate of 6.58 percent. What's the difference? The jumbo mortgage payment would be $2,887 a month instead of $2,657, a difference of $230 a month. Additionally, over the life of the loan, the total interest paid would be approximately $621,256 instead of $538,832, which is a difference of more than $82,000.
Lastly, for those homeowners whose homes have been foreclosed on, you say the IRS may be lurking?
Foreclosures are up 9 percent in July compared with June, and a whopping 93 percent from a year ago, according to RealtyTrac. In fact, one in every 693 households in the country was facing foreclosure in July, with Nevada, Georgia, Michigan, California and Colorado having the highest rates of foreclosure per household.
And, unfortunately the IRS does not issue a pass on foreclosed property. If you have already gone through foreclosure, the IRS may continue to wreak havoc on your shaky financial situation. If your lender forgives your debt through foreclosure, the IRS views this as income (even if you have no money to show for it) and you may owe income taxes on the amount forgiven, as well as any potential penalties and late fees. The exception is if your debt is canceled through bankruptcy. That said, before resorting to filing for bankruptcy, you should appeal to the IRS to determine if a lower, or potentially no payment, can be negotiated. For example, if you can prove you are insolvent, essentially that your debts far outweigh your assets, the IRS does not treat the forgiveness of debt as income.