High-LTV mortgages provide many options Just don't try to deduct debt above house value

Nation's Housing

September 27, 1998|By Kenneth R. Harney

CONGRESSIONAL auditors have taken a look at the home mortgage market's most controversial products -- loans that exceed the value of the home by 25 percent or more -- and pronounced them safe for the banking system, and for consumers.

In a new study, the General Accounting Office (GAO), the watchdog agency for Congress, says so-called "high loan-to-value" (high-LTV) mortgages do not pose major risks to financial institutions because their level of default by borrowers -- so far -- appear to be lower than defaults on credit cards. Moreover, says the GAO, the types of borrowers who obtain high-LTV loans earn more, and have higher credit scores than do average homeowners.

Introduced just three years ago, high-LTV mortgages break the traditional rules of home lending. Rather than requiring a borrower to pledge a stake in his or her home as security, high-LTV loans allow the homeowner to borrow more than the property's market value. Pitched aggressively on TV and through direct mail by football and baseball stars, high-LTV mortgages have grown from a $1 billion business in 1995 to an estimated $12 billion in new volume last year alone.

The typical loan works like this: Say you have a $120,000 house and a $100,000 mortgage. Your current "loan-to-value" ratio is about 83 percent ($100,000/$120,000); your equity is about 17 ,, percent. Say you also have $20,000 in revolving credit card debt you'd like to pay off, and a $20,000 car loan on a luxury vehicle.

If your credit measures up, and you have the income to make the monthly payments, a high-LTV lender may give you a second mortgage of $40,000 to pay off the cards and the car. Added to your $100,000 existing mortgage, your total "mortgage" debt will now be $140,000, "secured" by your $120,000 home. In fact, of course, you're now in a negative equity position. Your loan-to-value ratio is about 117 percent ($140,000/$120,000).

How's that beneficial to you? According to the GAO study, "Most borrowers decreased their monthly debt burden payments by using (high-LTV) loans to consolidate their credit card debts." That's because interest rates on unpaid credit card balances averaged 16 percent last year, while the interest rates on high-LTV averaged between 13 percent and 14 percent. Plus, at least some of the interest on your second loan should be tax-deductible.

In the example above, $20,000 of your new debt -- up to the home's value -- is tax-deductible. The $20,000 debt beyond the market value is not. Put another way, by rolling higher-cost debt on consumer-purpose loans -- all nondeductible on your federal taxes -- into slightly lower-cost mortgage debt that's partially deductible, borrowers should have more money in their pockets at the end of the month using a high-LTV loan.

The GAO study highlights several potential risks:

What happens to negative-equity borrowers in an economic downturn: This is a situation that could be just over the horizon if the Asian economic flu and global financial crisis trigger a recession here? "While borrowers might have benefited from restructuring debt using (high-LTV) loans during good economic conditions," said the GAO, they might default in large numbers if they lose their jobs. Citing the Texas recession of the 1980s and the Southern California recession of the early 1990s, the GAO found that when home values decline by 20 percent or more, borrowers' default rates rise rapidly.

Who says high-LTV borrowers won't rack up new credit card and auto loan debts once they've consolidated their existing debts? The GAO cites a study during the summer by a financial consulting firm that showed larger numbers of high-LTV borrowers doing precisely that.

Who says high-LTV loans are low cost? Though the rate on the second mortgages averages 13.5 percent, the GAO noted that high-LTVs come stacked with heavy "points." A point equals 1 percent of the loan amount. The average points charged applicants by one large lender, according to the GAO, is five. But others charge up to 12 points.

What does a high-LTV loan do to your ability to sell your home, or to refinance your mortgage? At the very least, having debt that exceeds your resale value definitely complicates life. For example, to sell your $120,000 house that's saddled with $140,000 debt, you're going to have to come up with not only the lenders' $20,000 balance, but 6 percent for the real estate agent, and a couple of thousand dollars for closing costs.

Otherwise, you may find that your debt-consolidation loan has landed you in the "Hotel California" of the Eagles' classic 1976 recording, where "you can check out anytime you like, but you can never leave."

Kenneth R. Harney is a syndicated columnist. Send letters care of the Washington Post Writers Group, 1150 15th St. N.W., Washington, D.C. 20071.

Pub Date: 9/27/98

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