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Financial Education for Everyone

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November 2, 2007

America's once red-hot housing market has cooled off considerably. Prices are down, unsold housing inventory is up and mortgage lenders have tightened credit standards.

What's worse, many borrowers who opted for adjustable rate mortgages (ARMs) are in for a big shock when millions of ARMs "adjust" to new, higher interest rates in the next few years. In a stronger market, these borrowers could simply refinance, using built-up home equity to qualify for lower, fixed-rate mortgages. Unfortunately, many now find themselves "upside down," owing more than their home's current value.

If you're in this situation, here are a few steps to consider before falling behind in your payments:

Carefully read your loan documents for terms that can make your interest rate rise or fall, such as:

  • When initial rate period ends, and when your rate is likely to start going up
  • Periodic rate cap (the most your interest rate can increase or decrease whenever your rate is readjusted – often annually)
  • Lifetime rate cap (the highest possible rate during your loan's life)
  • Index your rate is tied to (some indexes are more volatile, moving up and down more quickly)
  • If a balloon payment is ever owed
  • Prepayment penalties, in case you're able to refinance

Rein in spending. Your monthly payment could suddenly go up hundreds of dollars, so if you're already struggling, cut expenses now. If you don't already have a budget, create one. Practical Money Skills for Life, a free personal financial management site sponsored by Visa USA, has numerous budgeting tools that can help (www.practicalmoneyskills.com/budgeting).

Refinance to a fixed-rate mortgage, if possible. Well before your ARM readjusts, talk to your current lender and also shop around. With thousands of borrowers defaulting, lenders are more likely to negotiate if it means you'll stay a solvent, paying customer.

If you're in danger of missing payments or already have, contact your lender immediately and respond to all inquiries from them. It's better to work out a solution together than to let your options expire. Alternatives might include:

  • Repayment plan. Talk to the loss mitigations department about how you might catch up. They'll likely want at least partial payment initially and your agreement to pay on time thereafter.
  • Forbearance. Lenders sometimes allow suspended payments for a few months, especially for disaster victims, or after job loss or family emergency. After the forbearance period ends, expect to pay extra each month until caught up.
  • Loan modification. Where a lender agrees to modify loan terms with few or no fees. They might reduce the interest rate, convert to a fixed-rate mortgage, or possibly tack missed payments onto the end of the loan.
  • Short sale. Sometimes lenders allow owners to sell their homes for less than owed and write off the difference. The owner walks away with nothing except severely damaged credit.
  • Foreclosure. The lender takes possession of your home, you are evicted and your credit is severely damaged for at least seven years. Avoid foreclosure at all costs. The Federal Housing Administration offers comprehensive advice on avoiding foreclosure, including links to local housing counseling services, at www.fha.gov/foreclosure/index.cfm.

Talk to an attorney, financial advisor or housing counseling agency before taking any action and never make a payment to anyone other than your lender. Sadly, there are people who will take advantage of your bad circumstances.

Nobody wants you to lose your home, but you must take the initiative to find a solution before it's too late.


This article is intended to provide general information and should not be considered health, legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.