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Mortgages & Refinancing

Voices from the Home-Loan Bust

Three families cope with rising mortgage payments and declining property values.

It wasn't long ago that homeowners across the country were gloating over soaring home values in their neighborhoods. Now there's blood in the streets.

What at first looked like an inevitable downturn in the real estate cycle has turned ugly. Wall Street firms that once eagerly packaged mortgages into securities and encouraged lax lending standards and 100% financing are pressing lenders to tighten up. In response, lenders now require larger down payments or more equity, higher credit scores and closer scrutiny of appraisals.

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Although the vast majority of borrowers still make their payments on time, mortgage bankers report record rates of delinquency and foreclosure. A few high-profile subprime lenders -- firms that granted loans to people with blemished credit or undocumented income -- have declared bankruptcy. The National Association of Realtors predicts that the subprime sector's distress will prolong the housing slump and that the median home price nationwide will decline in 2007 for the first time since the Great Depression.

Even homeowners with the best credit feel the squeeze from falling home prices and rising rates. Toward the end of the boom, the number of adjustable-rate mortgages with cheap initial rates surged as home buyers struggled to get a foot in the door of houses selling for bloated prices. Now ARM payments are ratcheting upward even as home values slide.

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True, some homeowners cashed in their equity on goodies such as BMWs and expensive vacations. But many well-intentioned, overstretched homeowners are in payment shock and are unable to refinance because their equity has evaporated. Nor can they find buyers when selling is the only sensible way out.

Double trouble

Kevin Kempskie is not your typical buy-and-flip investor. In 2003, he bought a triple-decker -- three apartments stacked sandwich style -- in Attleboro, Mass., between Boston and Providence, R.I. In Boston, investors had already driven up prices and condo conversions were rampant, but Attleboro had escaped the rush and price run-up.

Kempskie, 33, put 5% down on the $365,000 property. He moved into the first-floor apartment with his wife, Heather, also 33, and collected rent on the other two units. He was confident that prices would rise and planned to convert the units into condos.

Within a year or so, he had accumulated at least 20% equity in the property through price appreciation. He refinanced and disposed of the private mortgage insurance that had cost him $285 a month -- money he could use to beef up his rental-property reserves or his household budget. Following his mortgage broker's advice, he traded in his fixed-rate mortgage for an ARM with a rate of 5.97% for the first year. The loan, known as an option ARM, offered four payment choices, including a minimum payment that didn't include all the interest due.

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Like many other risky mortgages, the loan carried a prepayment penalty that would apply if he refinanced within three years. Often, to boost their commissions, brokers would push for the prepayment penalty because it increased a loan's appeal to investment firms issuing packages of mortgage-backed securities.

Making the minimum payment quickly became the norm for the Kempskies. Their first child was born in 2003, and Heather wanted to take a year off from work. In 2004, their second child was on the way. The couple bought a single-family home and began making two mortgage payments.

A year after the refi, the interest rate began adjusting upward -- to 7.9% in April 2007. The $2,650 that Kevin collects in monthly rents is just enough to cover the loan's minimum payment of $2,370 and the building's operating expenses. He's deferring about $800 a month in interest, which is added to the loan balance.

Partly out of pride and partly because he believes the building is a good long-term investment, Kevin is reluctant to sell the property. Plus, paying the deferred mortgage interest would use up his original equity, and any sales expenses would cut into his proceeds even more. And because of the prepayment penalty he doesn't want to refinance until August.

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Watching his investment go sour has been stressful, says Kevin, especially because he pushed for the original refi despite his wife's aversion to risk. "She's a 401(k) gal," he says. The family budget has taken a hit. And opportunities are slipping by. "This would be a great time to buy," says Kevin, "but I don't have the means to do it."

Free-falling prices

Mike Franey, a mortgage loan officer in Bakersfield, Cal., saw trouble coming. For years, swarms of investors descended on his hometown, buying and flipping some of the cheapest housing in the state, driving up the area's median home price from $99,000 in 2001 to $280,000 in 2006. Franey, 63, feared that when the investors left for greener pastures, prices would decline and he and his wife, Mira, 60, might lose the equity in their home just as they approached retirement. "I said, 'We need to sell right now and rent until we can buy again cheaply,'" says Mike.

The Franeys sold in May 2006 -- just as prices peaked -- for $577,000, nearly twice what they had paid in 2002. They used some of the proceeds to pay off debts, and they moved into a much smaller rental home.

But for Mira, owning a home meant security. She hated renting and wanted to buy again. So the Franeys purchased a four-bedroom, two-bath house in a nice neighborhood for $420,000. They used an "alt doc" loan, one that lets borrowers state their income without proving it. Such loans have traditionally been used by people who, like Mike, have fluctuating income.

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For six months, Mike didn't make a single loan, and his six-figure income dropped by half in 2006. Struggling to make their mortgage payments of $3,200 a month and running out of savings, the couple tried to sell the home last fall but had no takers. Mike approached their lender, Countrywide Financial, and offered the deed in lieu of foreclosure. Countrywide refused to do anything until the Franeys were delinquent, a common practice among lenders for legal and tax reasons.

The Franeys missed their first mortgage payment in January, and in February they listed the home for sale at $368,500. Countrywide agreed to accept a "short sale," meaning it would cancel the couple's debt in exchange for the proceeds of the sale. Short sales save lenders the legal costs of foreclosure. In early May, the couple lost a buyer who had offered $350,000 but then found a better deal while everyone waited for Countrywide to approve the sale.

The house is back on the market and now stands vacant. The Franeys moved into a rental with an option to buy in three years. By then, Mike's loan underwriter tells him, he'll be able to get a mortgage again, as his credit score and his income improve.

Subprime victims

As investors and homeowners were overcome with speculators' fever, the mortgage industry fed Wall Street's hunger for high-yield securities by reselling packages of subprime loans. Says Charles Pope, president of Mortgage Authority, in Florida: "Mortgage companies were having such a good time selling bad paper, they said, Let's get crazier. If you can fog a mirror, we've got a loan for you." Encouraged by the ease of selling questionable loans to investors, lenders relaxed their underwriting standards.

Easy credit helped feed the housing boom in Florida and other hot markets. In St. Lucie County, Fla., the average home price doubled between 2002 and 2005, peaking at $263,700.

In that frenzy of building and buying, Linda Steele and her husband bought their first home in Port St. Lucie, the county seat. They paid $187,000 for a newly built four-bedroom, three-bath single-family home on a quarter-acre. After growing up in the projects of New York City, Steele, 34, was thrilled to own a home for her two daughters. At $1,500, the mortgage payment was manageable with two incomes -- although, as the family's primary breadwinner, Steele worked 14- to 16-hour days as a regional manager for a drugstore chain.

Steele's life began to unravel a year later, when she and her husband divorced. She did a cash-out refinancing to give him his share of their equity. Because of the decrease in household income, she had to refinance into a subprime mortgage. Called a 2/28, the loan featured a fixed rate of 8% for the first two years. It would then adjust every six months for 28 years.

Then life threw Steele a few more curves. She endured a yearlong period of serious illness that cost her time on the job. Her medical bills piled up, and she made some late mortgage payments. In mid 2006, when the fixed-rate period on her mortgage ended, Steele refinanced into another 2/28 mortgage, this time with an interest rate of 9% because her credit score had fallen. Property taxes rose with home prices to pay for new municipal infrastructure as new-home development mushroomed, and insurance costs soared in the wake of multiple hurricanes. Steele's mortgage payment rose to $2,800 a month.

Steele approached her mortgage lender hoping for a forbearance -- meaning she would be able to skip a few months' payments, which would be tacked on to the end of her loan. Instead, the lender told her that if she could pay her mortgage on time for three months it would consider adjusting the interest rate downward.

Despite regaining her health and finding a new job with good prospects, Steele couldn't make the first payment. She fears it's too late to make amends with the lender.

Steele still has equity in her home, but she isn't confident that she can sell it fast enough to avoid foreclosure. As she puts it: "Half the houses in Port St. Lucie are empty." Since the county's market peak, the number of homes for sale has more than doubled, time on the market has increased, and the median home price has fallen.

Even if Steele's lender agrees to work with her, she isn't sure that the struggle to keep her home would be worth it, given her situation -- "a single mom always at work." Steele says that no matter what happens, she believes good has come from her experience. Her daughters take less for granted, she says, and the three of them are closer than ever.