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Borrowers don't lack options, experts say

March 15, 2007|Kathy M. Kristof | Times Staff Writer

Eddie Oruna and Kerman Rogers are sub-prime borrowers, thirtysomethings with spotty credit histories who bought a three-bedroom home in Chino Hills in 2002 and then financed it to the hilt.

The interest rate on their two loans recently jumped more than 2 percentage points, and they're struggling to make monthly payments. To keep their mortgage current, they're setting aside other bills, which is thumping their credit ratings and hurting their chances of refinancing with a new loan they can afford. And that's the sort of thing that's making the country nervous.

Just 13% of mortgages are sub-prime, but if too many in the sub-prime sector default and sell at a discount or are pushed into foreclosure, the market will be flooded with inexpensive real estate -- diluting housing prices overall and possibly crimping the entire economy.

For Oruna and Rogers, there's a sense of urgency.

"We are really on the edge right now," Oruna says. "We don't really know what to do."

What are their options? We asked experts -- Steve Foster, president of Vista Financial, a mortgage brokerage firm in North Hollywood, and Jeff Lazerson, president of Mortgage Grader, a Web-based brokerage in Laguna Beach -- and put together a Q&A guide, starting with the basics.

What are sub-prime loans anyway?

They're mortgages for people with low credit scores, under 600 or so, and they're more expensive in terms of interest rates and fees than loans for the more creditworthy.

Why are they suddenly such a problem?

Because most of them come with adjustable interest rates.

Aren't a lot of loan rates adjustable?

Yes, but a sub-prime loan's terms make the adjustment far more painful. The interest rate on all adjustable-rate loans is determined by adding a "margin" (essentially the bank's profit margin) to an interest rate index, such as the one-year Treasury bill index or the 11th District Cost of funds index.

With a prime mortgage, the margin is usually 2.0% to 2.5% -- but with a sub-prime, it's 5% or even 7%. So the same movement in an index that sends the prime borrower's interest rate to 7% would boost the sub-prime borrower's interest rate to between 10% and 12%.

On a $300,000, 30-year loan, the prime borrower's monthly payment would go to $1,995.91 at 7% and the sub-prime borrower's would rise to $2,632.71 at 10%. That's a 32% difference.

What's more, the annual and lifetime caps on adjustable loans that keep rates from rising too far or too fast are higher on sub-prime loans; they frequently don't hit their caps until the interest rate reaches 15%.

So sub-prime loans are just more expensive?

Yes -- and most of them also include prepayment penalties, which are triggered if the loan is paid off before a set date. The time frame varies between one and five years, depending on the loan. And the penalty is stiff -- about six months' worth of interest payments, which work out to about five monthly payments. Moreover, the prepayment penalty applies regardless of the reason the loan is being paid off, even if the house is sold.

So what should I do if I suddenly can't afford my payments?

Pick up the phone and fast. Call your mortgage broker if you completely understood the terms of the loan when it was taken out (in other words, if you trust your broker enough to deal with him or her again), if you have some equity in your home and if you have a good enough credit rating to refinance. Your broker can investigate securing a lower-cost mortgage for you. If you don't have much equity or great credit, throw yourself at the mercy of your bank.

What good would that do?

It depends. Many sub-prime loans have been sold to investors, so the bank may need investor approval before making a deal. But because foreclosures are so costly, most investors and banks are willing to make an attempt to help borrowers by lowering the loan's interest rate or stretching out the repayment term -- or, in serious cases, letting delinquent borrowers off the hook for a month or two or more while they work out their financial problems.

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