When Joseph Yu and his wife, Nadia, took out a new loan on their house earlier this year, they had no idea they were tapping into the hottest new trend in the U.S. home mortgage market.
“All we wanted to do was get out from under our monthly credit card debts,” said Yu. “They were eating us alive.”
Yu, a 29-year-old businessman from Germantown, Md., said he and his wife had accumulated $30,000 in credit card, auto loan and other debts over the past several years. Minimum monthly payments totaled about $2,200. That was on top of a $900 monthly payment for mortgage principal, interest, property taxes and condo fees.
The solution for the Yu family: to mortgage their house for more than its market value, and use the bulk of the proceeds to pay off all their consumer debts.
After closing on their new loan, according to Yu, their total monthly payments dropped from $3,100 to $1,424–a 54 percent decrease. The $2,200 credit card outlay was replaced by a $524 monthly second mortgage payment.
The Yus’ new mortgage financing package is part of the rapidly growing move to what’s called “high-LTV” lending.
LTV stands for loan-to-value ratio. If you own a $100,000 house with an existing $90,000 first mortgage and you take out a second mortgage for $35,000, you’ve got an LTV of 125 percent.
The Yus’ $115,000 house now has a mortgage LTV of 114 percent: an existing $91,000 first deed of trust and a new $40,000 second mortgage funded by American Lending Group Inc., a Gaithersburg, Md.-based mortgage banking company.
Nationwide, according to Wall Street mortgage analysts, more than $10 billion worth of 100 percent or higher LTV loans will be financed in 1997–up from just $3 billion in 1996 and virtually nothing in 1995.
Volume in 1998 is projected to top $20 billion.
“It’s a type of financing that sounds bizarre when you first hear the term,” says Gordon Monsen, a managing director at PaineWebber Inc., the Wall Street securities firm. “It goes against the very core principle of traditional mortgage underwriting, which is that the borrower should have at least some equity in the property, like a down payment.”
But Monsen says home loan-to-value ratios of 100 to 135 percent “are prudent for lenders and investors,” provided the borrowers have good to excellent credit profiles.
Whereas both Fannie Mae and Freddie Mac insist on credit scores of 620 or higher, typical high-LTV borrowers have scores of 650 to 700 or higher, measured by the “FICO” electronic credit-scoring system developed by Fair, Isaac & Co. and used by lenders nationwide.
Like Joseph and Nadia Yu, most high-LTV borrowers have good incomes, solid jobs and good debt repayment histories. They also have a weakness for credit cards, and are stretched to the limit.
Though a second mortgage industry exists to help debt-burdened consumers with “consolidation” loans, until recently most lenders wouldn’t even consider extending credit where the combined debt loan of the existing first mortgage and a new second exceeded 90 percent or 95 percent of home value.Is high-LTV borrowing for you? Here are some thoughts:
– A 125 percent LTV loan isn’t for you if you’ve run up big credit card balances and have been seriously late on repayments. Delinquencies can knock your credit score below the minimums for high-LTV.
– High-LTV second mortgages aren’t cheap. Typical rates run from about 13 percent–for the best credit–to 16 percent. But they’re almost always lower than the 18 percent to 22 percent charged by credit card issuers.
– Don’t plan on moving soon if you take out a high-LTV mortgage. If you have combined first and second liens of, say, $200,000 on your $175,000 house, you’re going to need to bring money to settlement–not collect it–when you sell.
