In the throes of the subprime meltdown, most mortgage lenders tightened lending standards, requiring borrowers to have credit scores of at least 700 and down payments often of 10% or more. But as the credit crunch takes a toll on consumers' credit scores and cash positions, questionable lending practices are beginning to pop up again.
“Since early this year … a new wave of people are finding ways to scam (homebuyers),” says Dani Babb, dean of business at Andrew Jackson University, an online university based in Birmingham, Ala., and founder of The Babb Group, which offers real-estate consulting to consumers.
Combine such risky deals as 100% financing and piggyback loans with skyrocketing interest rates and fees and it could spell disaster — both for borrowers' bottom lines and
the economy, says Chip Cummings, president of Northwind Financial, a Grand Rapids, Mich.-based training and consulting firm for mortgage and realty firms.
- MSN Money: Have $2,500? Buy a house
Here are five risky financing offers that prospective homebuyers should watch out for:
1. Hard money lending
A hard money loan may seem attractive to those who have had a run of bad luck, but it will cost them dearly.
Most hard money lenders don’t place emphasis on a borrower's credit score or employment status and will even offer loans to borrowers who have been rejected for government-backed or private mortgages. On average, these mortgages charge interest of anywhere from 10% to 14% and can require the borrower to pay up to five points, or 5% of the loan, upfront, says Leonard Baron, adjunct professor of real-estate investing at San Diego State University. (One point equals 1% of the loan. Currently, the average mortgage rate on a 30-year fixed is 5.81% and typical mortgages charge from zero to 0.5 points, says Keith Gumbinger, a vice president at HSH Associates, a mortgage data firm.)
And in return for taking on the extra risk, many hard money lenders require the borrower to make a down payment of around 30%, Baron says. Some may even offer mortgages with zero money down, but require borrowers to put up collateral — like their car, Babb says. The problem here is that these loan contracts are often so confusing that some borrowers don't realize they are signing away their assets, she says.
Bottom line for the borrower: Not only will you pay sky-high interest, but borrowing from a hard money lender has the potential to dig you into a deep financial hole should you fall behind on payments, Baron says.
Risk for the economy: Hard money loans make up less than 1% of the mortgage market, Baron says. “But the number of people turning to them could grow if the credit crunch continues,” he says.
2. Advances on the First-Time Homebuyer Tax Credit
The First-Time Homebuyer Tax Credit, which offers up to $8,000 to qualifying buyers who purchase a home through Nov. 30, is a generous perk worth taking advantage of. But it can also get some homebuyers into deep trouble.
In late May, the Department of Housing and Urban Development said it would permit FHA-approved mortgage lenders to offer eligible borrowers an advance based on the tax credit. Borrowers, in most cases, are still required to make the standard 3.5% down payment required for FHA-insured mortgages, but they can add the value of the credit to the down payment or they can use it to pay for closing costs, Cummings says.
Repayment rules vary, but depending on the lender, borrowers will have to pay the loan each month, pay a lump sum when they receive their tax credit or make payments
over several years. And, in most cases, they'll be paying interest, too. (HUD recommends that lenders refrain from charging fees that surpass 2.5% of the tax credit.)
Bottom line for the borrower: If borrowers need to rely on an advance of their tax credit to afford the purchase, then they'll probably have a hard time affording both their loan payments on the advance and the mortgage payments, Cummings says.
Risk for the economy: “We’re building a house of cards like we did before,” Cummings says. “We’re getting people into homes that they can’t necessarily afford with no equity, which is artificially propping up the market.” A new ripple effect of foreclosures could occur in the next two years as a result of this practice, he says.
I would also like to mention that it is not lenders giving the tax credit up front... it is approved non profit organizations that set up those seconds. Lenders are not the ones that make up the terms of those notes.
