MORTGAGES; Defaulting on Second Homes

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SOME affluent homeowners have been walking away from a second home or investment property that is worth less than what is owed on the mortgage, even though they can still afford to make the payments.

But dumping that beach condo or country cottage, or even a home bought for an adult child -- a practice known in the industry as a ''strategic default'' -- is not the same as discarding a poorly performing stock or bond. Among the lingering effects is wrecked credit that can prevent the homeowner from getting another loan of any kind for 7 to 10 years.

In July, a study by researchers from the European University Institute, Northwestern University and the University of Chicago concluded that the strategic default trend was ''large and rising'' among homeowners with an equity shortfall of $100,000. As of last March, it said, strategic defaults accounted for 35.6 percent of all foreclosures, compared with 23.6 percent a year earlier.

''I'm increasingly seeing people who are middle class or higher on the pay scale coming to the conclusion that 'I may be able to carry it, but should I?,' '' said David Shaev, a bankruptcy lawyer in New York who assists homeowners in distress.

''But the question is, can the bank come after you, and if so, what is your position? What is your liability?''

The answer depends largely on where the property is.

In ''recourse'' states, a lender can come after you, and usually other assets like a primary residence, for the full mortgage amount. In ''nonrecourse'' states, a lender agrees to accept whatever the property fetches at a short sale, foreclosure sale, or a deed-in-lieu, in which the property is taken back but not formally foreclosed on, and generally can't sue for the full loan amount. Connecticut and Arizona are among the nonrecourse states, while Florida, Colorado, Maine, New Jersey and Hawaii are recourse states.

There is a third category of state, called ''single-action'' or ''one-action,'' which allows the lender either to foreclose on the owner or file a civil lawsuit for the full loan amount. New York, California and Idaho are in that category.

Even in a nonrecourse state, however, those homeowners who opt for a strategic default on a previously refinanced property may not be protected from lenders, because the mortgage in such a case was not accorded for a first purchase, said Philip Faranda, a mortgage broker for J. Philip Real Estate, in Briarcliff Manor, N.Y.

When home-equity loans are involved, he added, it gets more complicated. In nonrecourse states like Florida and Connecticut, the lender cannot sue to collect any home-equity loan taken out on the property. But in nonrecourse states like Arizona and California, the lender can still sue for repayment of a second mortgage or line of credit.

Filing Chapter 13 bankruptcy protection, in which the homeowner arranges to pay off debts at lowered amounts over a maximum of five years, is typically the only way to avoid being on the hook for the second loan, mortgage experts say. Affluent homeowners who strategically default on a second home often don't qualify for Chapter 7 bankruptcy, which leads to liquidation but limits eligibility to those earning no more than state median income levels.

Though not illegal, strategic defaults are controversial, because they are viewed in some circles as unethical. The practice is common among property developers.

For homeowners under water, experts say, it can make economic sense. ''It's a business cash-flow decision,'' Mr. Faranda said, ''but the risk is that you're rolling dice with your future credit.''

A foreclosure from default stays on a homeowner's credit report for 7 years, while filing for bankruptcy stays on the report for 7 to 10 years, he said. A default can lower a credit score by 85 to 160 points, according to FICO, the company that created the scoring method.

CHART: INDEX FOR ADJUSTABLE RATE MORTGAGES: 1-year Treasury rate (Source: HSH Associates)

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MORTGAGES; A Refinancing Alternative

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HOMEOWNERS looking to lower their monthly mortgage payments and also save some on interest may be able to do so without all the hefty fees and daunting credit requirements of refinancing.

A little-known strategy, called ''recasting,'' or ''re-amortization,'' is available through some mortgage lenders and servicers.

It involves paying off a lump sum of the principal amount and asking to have the monthly payments reset according to the original interest rate and loan terms. The lump sum reduces the principal, so your new monthly payments decrease slightly and you save on interest paid over the life of the loan.

Lenders typically charge an administrative fee of $150 or more for this service, though borrowers are not required to pay closing costs or submit to another credit check, because they are not asking for a new loan.

Recasting works well for those unable to qualify for refinancing amid the ever-toughening credit guidelines -- perhaps because they are self-employed or have less-than-stellar credit -- as well as for those with extra cash, like a year-end bonus.

''People don't really know about it,'' said Alan Rosenbaum, the founder and chief executive of the Guardhill Financial Corporation in New York, ''but it's become more common recently.''

Although the term ''recasting'' is often used by the mortgage industry to refer to interest-rate resets on adjustable-rate mortgages, here the interest rate and loan term stay the same.

Here's how it might work. Let's say that as of late December, you had just over $230,449 of principal left on a 30-year fixed-rate loan for $300,000 taken out at 7.93 percent in 1995. You have been paying just under $2,187 a month in principal and interest. But if you put in $20,000 toward that remaining principal and asked your lender to reamortize your payments over the remaining 15 years on the loan, your monthly payment would drop by $184, to around $2,002. Putting in $100,000 would save $945 a month and bring payments to $1,241.

Making extra payments toward the principal while not asking the bank to recast a loan keeps monthly payments the same and merely shortens the time it takes to pay off the loan.

There are a few caveats to recasting, however. The first is that you may need to have a large sum on hand. JPMorgan Chase, for example, charges a $150 fee and requires a minimum $5,000 payment toward the principal.

Another issue is having a lender, or loan servicer, that offers the service. And even those that do may impose restrictions. JPMorgan Chase and Bank of America exclude loans backed by the Federal Housing Administration and the Department of Veterans Affairs, and loans that were sold off and securitized may also need investor approval.

While few if any lenders advertise recasting, ''they are trying to become more customer-service-oriented, and they will do it on a case-by-case basis,'' Mr. Rosenbaum said. Homeowners should contact their lender's customer service department.

Lenders, which would probably rather earn thousands of dollars in closing fees from refinancing your loan, are not obliged to recast mortgages. And certain types of mortgages, for example interest-only and adjustable-rate loans, usually aren't eligible. The borrower will also need to have been current with all mortgage payments to qualify.

Edward Ades, the owner of Universal Mortgage in Brooklyn, says recasting can be especially useful to recent buyers, for whom it makes little financial sense to refinance but who expect to receive a tax refund or other substantial money after closing on their property, like proceeds from a relative's sale of property, stocks or other assets.

If your interest rate is 5 percent or lower, Mr. Ades added, it may not make sense to recast a loan, because the extra cash could be put into an investment with a higher return. ''At the end of the day,'' he said, ''I always tell people they have to do whatever makes them sleep better.''

CHART: INDEX FOR ADJUSTABLE RATE MORTGAGES: 1-year Treasury rate (Source: HSH Associates)

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MORTGAGES; New Lending Guidelines

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NEW lending guidelines being rolled out by Fannie Mae will make securing a mortgage a lot easier for some borrowers but harder for others.

The rules, effective on Dec. 13, will allow buyers to use gifts and grants from nonprofit groups for their minimum 5 percent down payment, which is the threshold set by Fannie Mae, the government-owned company that sets lending standards and buys mortgages from lenders. (Freddie Mac is considering similar new guidelines, said Brad German, a spokesman.)

Previously, borrowers had to contribute a minimum 5 percent down payment from their own funds, but additional down payment money could be from a gift (though never from a home seller). The exception was for borrowers who put 20 percent down: all that money could come as a gift.

Because many lenders now require a down payment of 10 percent or more, the new rules mean that borrowers will still have to come up with extra funds -- either their own or gifts.

Still, ''this is definitely going to help upgrade buyers and young couples who for whatever reason don't have enough money and are getting some from their families,'' said Edward Ades, the owner of Universal Mortgage, a broker in Brooklyn.

The gift rules apply only to single-family principal residences, including town houses, co-ops and condominiums, and covers mortgage amounts in excess of 80 percent of the property's value. Also, there is a limit on the loan balance -- $729,000 in high-cost areas like New York City, and $417,000 in other areas.

Now, the not-so-good news.

Fannie Mae is getting tougher on debt-to-income ratios, or the amount of a borrower's gross monthly income that goes toward paying off all debts. The maximum ratio for those seeking a conventional mortgage will drop to 45 percent from 55 percent under the new guidelines.

The agency is also taking a harder look at payment histories on revolving debt. In the past, if a borrower missed a monthly payment, Fannie Mae ignored it, or required that lenders add a few percentage points to the total balance when calculating the debt-to-income ratio. Now, buyers who have missed a payment will have 5 percent of the total balance added to their ratios.

Mr. Ades said that new hurdle could sink many potential borrowers with student-loan debt that has been deferred.

Susan A. Kreyer, the president of the New York Association of Mortgage Brokers, added that buyers who had bought big-ticket items through financing with delayed payments would also be affected.

In addition, Fannie Mae is scrutinizing people who are at the end of their mortgages, with 10 or fewer payments left. It will now count those remaining balances in the debt-to-income ratios -- another departure. Mortgage experts say that older buyers near the end of their loans may now have a tougher time securing a loan for a second home.

But perhaps the toughest news from Fannie Mae concerns borrowers who have gone through foreclosure. They will be excluded from obtaining a Fannie-backed loan for seven years, up from five. ''That's a long time in this economy,'' Ms. Kreyer said. That change was announced separately from the gift and debt rules, but will also take effect in Fannie Mae's automated underwriting systems next month.

Fannie Mae buys or guarantees around $3.2 trillion in residential loans, about 28 percent of the entire residential mortgage market in the United States. Lenders typically issue loans based on the agency's guidelines.

Buyers who do not meet the new Fannie Mae requirements may have to consider a nonconforming loan from the Federal Housing Administration. These loans, which do not follow Fannie Mae underwriting guidelines, require mortgage insurance premiums and, for those with low credit scores, higher interest rates and steeper down-payment requirements.

CHART: INDEX FOR ADJUSTABLE RATE MORTGAGES (SOURCE: HSH Associates)

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MORTGAGES; When Rate Locks Expire

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AS mortgage rates have edged higher, many borrowers have been locking in loan rates for a home purchase or refinancing.

A lock-in agreement -- also called a rate lock or rate commitment -- protects against sudden spikes in interest rates by freezing the terms of a loan while it is being processed, which could ultimately save a borrower tens of thousands of dollars in interest costs over the life of the loan.

For every percentage point rise in rates, 300,000 to 400,000 would-be buyers historically are priced out of the market in a given year, according to the National Association of Realtors.

The average rate nationwide on a 30-year fixed-rate loan, the most common type of home mortgage, hit 4.86 percent at the end of 2010, up from 4.17 percent in early November, according to Freddie Mac. On Thursday, the rate was 4.77 percent.

While lenders and mortgage brokers have reported an increase in lock-ins as rates have risen in recent weeks, they say these guarantees have been complicated by changes in the Truth in Lending Act -- which add more protection for consumers but also lengthen the loan-application process.

In 2010, the average mortgage took 52.1 days to close, up from 46.9 in 2009, the year the new regulations took effect, according to J. D. Power and Associates, a marketing information company. (It was also the third consecutive annual rise, the company said.)

As a result, an increasing number of borrowers who elected to lock in their rates at the end of last year but did not close on time must now arrange extensions of their lock-in agreements.

Borrowers could end up paying at least several hundred dollars in extension fees to lenders. Most lenders charge from 0.10 to 0.25 of a percentage point of the loan amount for a 15-week extension; for a $400,000 loan, that can amount to $400 to $1,000.

Of course, a number of other factors can also impede a closing -- especially considering the industry's tighter lending requirements. These range from lower credit scores, to delays in securing appraisal, to incomplete submission of documents verifying income.

Most rate locks last from 30 to 60 days, though some may be as short as 7 days or as long as 120.

Irene Amato, the owner of the A.S.A.P. Mortgage Corporation in Cortlandt Manor, N.Y., recommended that borrowers take out a lock for 60 to 90 days, especially for a refinancing -- which, she said, could take a little longer than a home purchase because of a backlog of applications.

Another big hurdle for borrowers is navigating a crazy quilt of lock-in policies from different lenders. Some may require that a borrower have a specific property chosen, for instance, while others may not.

''EVERY lender is different,'' said Jim Guerriero, the branch owner of First Lenders Mortgage, a mortgage broker in Middletown, N.J.

Some lenders will offer 60-day lock-ins free of charge, while others may charge ''points'' -- or fractions thereof -- based on the size of the loan, which could amount to several thousand dollars. (A point is equal to 1 percent of the loan amount.)

If your credit score plummets after you've signed a rate lock, lenders in some cases might rescind the lock. And some rate locks have buried in their fine print a caveat that a rate can in fact rise a quarter of a percentage point or so and still be considered applicable to the borrower.

''All I can say,'' Ms. Amato said, ''is get everything in writing -- every last detail.''

The Federal Reserve recommends having a real estate lawyer review a rate-lock agreement before you sign one. It has a consumer guide available at its Web site.

CHART: INDEX FOR ADJUSTABLE RATE MORTGAGES: 1-year Treasury rate (Source: HSH Associates)

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MORTGAGES; Taking Custody of the Loan

DIVORCED homeowners wrangling with the task of removing a former spouse's name from the mortgage after buying out his or her equity stake in the marital house may think that refinancing is the only choice.

There is another, little-known option that can avoid refinancing and its costs, which generally run 3 to 6 percent of the outstanding loan principal, according to LendingTree. You simply ask your lender to remove the former spouse's name, leaving the loan note in your name only.

The problem is that not all lenders or mortgage servicers offer this option, known as release of liability. The lenders and servicers that do will most likely run a separate credit check on you -- requiring, for example, that you meet minimum credit scores (typically from Fannie Mae, the giant government buyer of loans), and ensuring that you are current with the monthly mortgage payments. They may also require that any investors in the loan, after it is sold off, agree to the deal.

And if you are ''under water,'' and owe more on the mortgage than the home is currently worth, this process is not an option.

''This is a common and often messy business,'' said Jack Guttentag, a mortgage expert and emeritus finance professor at the Wharton School of Business at the University of Pennsylvania. ''Lenders seldom have a reason to take a co-borrower's name off the note.''

But, he added, if a homeowner can prove that he or she can afford the payments and meet the required credit criteria -- typically those of the investor in the loan -- then release of liability may work.

Neil B. Garfinkel, a real estate and banking lawyer at Abrams Garfinkel Margolis Bergson in New York, says the lender ''will require the borrower to prove that the borrower is able to support the monthly payments without the co-borrower spouse,'' typically through monthly bank statements, annual tax returns and investment statements.

Having the name removed protects the credit of both parties, actually. If the former spouse failed to pay other debts, a lien could be placed on the home, and if you were delinquent on the mortgage payments, your former spouse's credit could be hurt.

Most divorce settlements stipulate one of two outcomes for marital property. Either the house must be sold, or the person wanting to keep the property must buy out the other's share, usually within months of the date of the settlement, and get the other party's name off the mortgage -- either through refinancing or a release of liability -- typically within a year.

Under the second option, the former spouse signs a quit-claim deed at the divorce settlement, relinquishing his or her claim to the property. But while that action takes the former spouse off the house's title and leaves it in one name only, it does nothing to remove his or her name from the actual mortgage.

Lenders or servicers typically charge $300 to $1,000 to execute a release of liability and require the property owner to pay an additional, nonrefundable application fee, typically $250 to $500. The process can take from 30 to 90 days, mortgage experts say.

One mortgage servicer, PHH Mortgage of Mount Laurel, N.J., requires that a homeowner with a loan sold to Fannie Mae have a minimum FICO credit score of 620 and a debt-to-income ratio of 50 percent or below (the ratio measures the amount of gross monthly income that goes to paying off all debts).

Still, a lender or servicer ''generally has no obligation to release one of the borrowers,'' Mr. Garfinkel said.

But Mr. Guttentag says homeowners may have one point of leverage. He suggested that qualified borrowers not accorded the release they seek tell their servicer or lender that unless a release of liability can be executed, the borrower will refinance the mortgage -- at another lender.

''In such cases,'' he said, ''the servicer might agree to do it.''

CHART: INDEX FOR ADJUSTABLE RATE MORTGAGES: 1-year Treasury rate (Source: HSH Associates)

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