The mortgage market is a sensitive and complicated system. It reacts to any number of factors, including interest rates, housing purchases, and general economic outlook. It’s been in turmoil since the 2008 crisis and is still in the process of finding a new equilibrium. Last week was particularly tumultuous. What does all this turbulence mean for homeowners and home buyers?
What’s happening in the market?
The current upheaval in the mortgage market is a result of changing interest rates. The Fed has kept rates extremely low for years in an attempt to revitalize the housing market. If rates are low, the thinking goes, people are more likely to be able to afford mortgage loans to buy homes. The housing market has, in fact, been steadily improving. Unfortunately, nothing is ever quite that simple.
Now that the housing market and the economy in general are looking up, interest rates are slowly rising. In addition, home prices are rising as the market recovers. That means both homes and the loans needed to purchase them are getting more expensive. And that leads to a lot of churn in the market.
Interest Rates and Mortgages
When you take out a mortgage loan, you may be able to choose between a fixed interest rate and a floating interest rate. A fixed interest rate means you lock in the interest rate when you take out the loan. If interest rates are 4% on a 30-year mortgage that day, you’ll pay 4% for the rest of the life of the loan. Fixed rate loans can save you a lot of money if interest rates go up. Of course, you may also get stuck with a higher-than-market rate if interest rates go down.
A floating interest rate, in contrast, changes with general interest rates. A floating rate is frequently pinned to some larger measure, such as LIBOR or 10-year Treasury Bonds, with a percentage on top. For example, you could take out a 30-year loan at LIBOR plus 2%. With a floating interest rate, you save money if rates go down. If rates go up, you’ll be stuck with the rising rates.
Whether you choose a fixed or floating rate will depend on your borrowing needs, what you can afford, and your appetite for risk. Locking in a reasonable rate is a more conservative move – you can plan ahead and you’ll always know what you owe. Using a floating rate is riskier, but can save you money if rates drop over the life of your loan.
The change of interest rates over time also leads some mortgage borrowers to refinance their loans. Refinancing a loan means, in essence, that you take out a new loan with a new interest rate. If you have a fixed-rate loan and loans have dropped, you might want to refinance to capture and lock in the new lower rate. If you have a floating rate loan and you think rates are going to go up, you might want to refinance and lock in your current rate before rates rise any further.
What’s the panic?
While rates are currently unstable, sometimes rising and sometimes falling, it looks like rates are going to start moving up from now on. That has a lot of borrowers worried. A difference of just a fraction of a percent can push your monthly mortgage payment up by $100 or more. That will cost you thousands of dollars more over the life of your loan. With rates trending upward, borrowers are forced to make quick decisions about how to handle their loans. People with floating rates are scrambling to lock in fixed rates before they rise. People with fixed rates are considering refinancing now in order to keep the lowest rate possible. People who want to pull cash out of their homes are racing to get second mortgages while rates are still relatively low.
With rates and home values both rising, applications for new mortgages are dropping quickly. Borrowers are still nervous after the 2008 crisis and no one wants to be stuck with an expensive mortgage for an over-valued home. As rates rise, so do the risks of landing in underwater mortgages. That’s a result of the way the housing markets work. Home prices have risen as a result of the improving economy and tight supply. While rates were reliably low, people could still afford to purchase homes even with rising prices. Now that interest rates are rising, homes are less affordable and less people are buying. That pushes home prices back down, meaning people who have recently purchased homes are losing value. It’s a delicate balance that’s leading to a lot of mortgage market panic.
Lien Stripping in Chapter 13 Bankruptcy
All of these factors combined can put people underwater on their home loans. With homes starting to lose value, borrowers may be looking for ways to get out of excess debt. One way to handle that debt overload is through a Chapter 13 bankruptcy.
When you file a bankruptcy under Chapter 13, you agree to a 3-5 year payment plan based on your earnings. You can continue to make regular mortgage and car payments and the rest of your monthly payment will go to pay off your unsecured debt, such as credit card and medical bills. At the end of the payment plan, your remaining unsecured debt is discharged.
Chapter 13 also gives you an important option for dealing with second mortgages and home equity loans. In Chapter 13, you have the option to “strip” a secondary loan from the home that secures it if your first mortgage is underwater.
Say you own a home worth $200,000, you owe $180,000 on your primary mortgage, and you have a second mortgage for $50,000. Your home is security for the loans. If you don’t make your payments, the banks can sell your home through the foreclosure process. Assuming the home sells for the $200,000 it’s worth, the primary mortgage holder will get its full payment before the second mortgage holder gets anything. So, your primary mortgage lender would get $180,000 and your second mortgage lender would get $20,000. In that case, Chapter 13 bankruptcy won’t affect either loan.
Now, say you own a home worth $200,000 you owe $225,000 on your primary mortgage, and you have a second mortgage for $50,000. The second mortgage is “wholly unsecured” – if the house were sold, the second mortgage holder would get nothing from the sale. Chapter 13 allows you to separate the second mortgage from the home, terminating the second lender’s right to an interest in your property. That makes this second mortgage or home equity loan an unsecured debt, which means it will be discharged at the end of the process. In other words, Chapter 13 can free you from a loan that’s putting you underwater on your home.
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