Joe Areias knows all about the pitfalls of subprime loans — both as a lender and a borrower.
Over the last 10 years, the loan officer made a good living in the mortgage business, earning enough to buy his own Garden Grove, Calif., condo four years ago.
But Areias, 41, got behind financially last year after taking time off work to care for his ill wife and new baby. As the mortgage business slowed, he struggled to make the payments on the subprime loan he refinanced into two years ago.
His options dwindled in August, when he was unable to refinance again after the teaser rate on his loan ended and his payment adjusted higher.
His last hope died last month when the only deal he had going with a client fell apart after Fremont Investment and Loan, a major subprime lender in Brea, Calif., cut off its lending. On March 1, Areias received a foreclosure notice on his own condo.
Financial experts have two words of advice for the thousands of homeowners in trouble: Act now. You may be able to save your home, and if you can’t, at least you can take steps to soften the financial blow.
If you don’t take the initiative, they warn that you may not only find yourself out of a house, but also still owing money to the lender or the IRS.
“Don’t think you can just turn over your keys and walk away,” says Norm Bour, a Laguna Niguel, Calif., mortgage expert.
This is no time for wishful thinking.
Experts recommend you start by calling your lender — immediately — to explain why you are falling behind on your payments or may not be able to afford the loan when the rate resets higher.
Some lenders are allowing borrowers to adjust their terms. Freddie Mac, the quasi-government enterprise that buys mortgages, is offering incentives for lenders to help borrowers get up to date on the payments.
If you have equity in the house, you may be able to refinance. This may trigger a stiff prepayment penalty, Bour says, but it may be worth it to get a loan you can handle.
With home sales slowing and prices dipping in some areas, many desperate sellers may face a so-called short sale, which is when the house is sold for less than the mortgage.
There could be an advantage to a short sale for homeowners who still have the original mortgage they got when they purchased the house, says Bradford L. Hall, an Irvine, Calif., certified public accountant and head of Hall & Co.
If the property sells for less than the original purchase-money loan, the lender must by law accept that as payment of the borrower’s obligation, he says.
Homeowners who have refinanced, however, face a different situation. A refinanced loan is considered a “recourse” loan, meaning the lender can come after the borrowers personally for payment of any difference between the mortgage and the sales price.
For instance, if you refinanced your mortgage for $650,000 and sold the home for $600,000, the lender can sue to recover the so-called deficiency — in this case $50,000. The lender can seek repayment from your other assets — savings accounts (except retirement accounts), other property, your paycheck.
Selling for less than you owe on a recourse loan, however, may create a different problem. Many lenders opt not to take a homeowner to court to recover the money. Instead, lenders write off the loss and send the IRS a Form 1099 for the so-called deficiency.
The IRS treats the shortfall as income, so the borrower will not only be out of a house, but also will owe income taxes on the difference between the mortgage and the sales price. And it is taxed at the ordinary income rate, not the typically lower capital gains rate.
