The 2007 and 2008 U.S. mortgage crisis brought mortgage problems to the forefront of media attention and sent property values tumbling. Fortunately, although difficulties can arise when you take on a mortgage, fortunately, there are plenty of mortgage problems you can prevent by making an informed decision when it comes to home buying.
Mortgage Problems You Can Prevent
Some mortgage problems cannot be prevented. For example, if you lose your job or someone becomes medically ill, it may become difficult to pay your mortgage. Furthermore, despite your best efforts, home values can fall. However, if you borrow responsibly, and follow simple advice, there are many mortgage problems you can prevent. Mortgage problems that you can prevent, in most cases, include:
- Unaffordable Payments
- Not understanding the terms of your loan
- Being upside down on your home
- Unaffordable Payments
The inability to make your payments is one of the most important mortgage problems you can prevent. If you are unable to make your payments, you are in danger of defaulting on your mortgage. Your credit can become destroyed, you can lose the equity in your home, and you may be forced into bankruptcy if your mortgage payments are not affordable.
This mortgage problem can be prevented by not buying more home than you can afford. Conventional wisdom suggests that your monthly mortgage payment, including insurance and property taxes, should not exceed 25-33% of your gross monthly income (your income before taxes). That means if you make $2500 per month before taxes are taken out, you can afford monthly mortgage payments of between $625 and $825 per month. You should typically not take a loan that amounts to more than this dollar value. In fact, if you have a lot of debt already, you may want to err on the side of caution and borrow a bit less.
Even if you are conservative, payments can become unaffordable if you suffer a financial setback. As a result, you should usually aim to have an emergency fund when you buy a home. Experts recommend that you have anywhere between 3 months and 12 months of living expenses saved in the bank. This can ensure that foreclosure and default is one of the mortgage problems you can prevent. Even if you lose your job, or suffer a financial setback, you will be able to use your emergency fund to make your payments until you either sell your home or get back on your feet.
Not Understanding Your Loan
Not understanding your loan is one of the most important mortgage problems you can prevent, as this can lead to many other difficulties. Ensure that you understand everything you will need to pay, including your monthly mortgage payments, insurance payments and property tax values. If you are not selecting a fixed loan, in which your interest and payments remain certain for the life of the loan, then you need to be especially careful to understand what your alternative financing arrangement entails.
If you opt for alternative financing, such as an adjustable rate mortgage, a balloon mortgage, or an interest only mortgage, you increase the risk that mortgage problems will develop. In an adjustable rate mortgage, interest could in some cases become so high that you are unable to pay. In a balloon mortgage, you may be unable to refinance when the balloon payment comes due. In an interest-only mortgage, you could find yourself owing more on your home than you owe. Before selecting one of these options, which are usually used to get you into a house that you cannot quite afford, ensure you fully understand the risks and are equipped to deal with problems that might arise.
Being Upside Down on Your House
If you are upside down on your house, that means that you owe more on the property than the home is worth. This commonly occurs for several reasons:
- Failure to put a down payment on a house
- Falling property values
- Alternative financing arrangements
- Second or third mortgaging
Your down payment provides you with equity in the home. This is the value of the house that belongs to you, not the bank. If you do not put a down payment down on the house and property values fall, your house may not be worth as much as you owe. The same problem can occur in alternative financing arrangements, especially with interest only mortgages. If you are not paying down principle, you are not building equity. If home values fall, you may again end up owing more than the home is worth. Finally, many homeowners tap into the equity in their homes, borrowing against it using second or third mortgaging. This, too, can lead to owing more than a home is worth.
If you owe more than your home is worth, you will be unable to sell or refinance unless you can come up with the cash to pay the bank the difference. This means that if you need to move or sell, you may be forced to negotiate a short sale unless you come up with the cash. This can have an adverse impact on your credit. Furthermore, if you become unable to make the payments, the bank may foreclose on your home. If they do not recover as much as they owe after a foreclosure, they may even try to get a deficiency judgment against you in which you are obligated to pay the difference. Foreclosures and short sales are among the most serious mortgage difficulties, but are mortgage problems you can prevent by acting carefully and borrowing responsibly.
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