Shortchanged by Howard Karger

Author:Howard Karger
Language: eng
Format: epub
Tags: ebook, book
Publisher: Berrett-Koehler Publishers, Inc.
Published: 2011-06-27T16:00:00+00:00

EQUITY STRIPPING

Larry and Erica Huffman are in their mid-40s and have two school-age children. They live in Des Moines, Iowa, in a house they bought for $120,000 in 1995. The house is now worth $175,000 and climbing.

Larry is a shipping clerk and Erica works as a bank teller. Neither of them has had a significant pay raise in years. Over the last decade, Larry and Erica have seen the real value of their incomes stagnate while their expenses have soared. Larry could compensate for this by working longer hours, but his company has cut back on overtime. Erica never had that option. The Huffmans made up their financial shortfall by shifting some of their expenses to credit cards and high-interest consumer loans. Over the years, their credit card balances grew, and they resorted to taking out new cards to pay the interest on their old ones. By 2002 the couple faced a credit card debt of almost $35,000, much of it in high-interest cash advances. Their savings account was long depleted, their cars were financed, and they had no assets except their home. The sole remaining option was to refinance.124

The Huffmans had saved enough for a 20% down payment when they bought their home. Since their credit was good at that time, they got an 8% mortgage. However, in the intervening years their income-to-debt ratio increased, they had several late credit card and utility payments, and a few mortgage payments were more than 30 days late. This was enough to push them into a higher risk category.

Although the Huffmans initially wanted a home equity loan, the mortgage broker convinced them that refinancing was a better option. The new appraisal came in at $175,000, and they owed $84,000 on the mortgage. Using an 80% loan-to-value (LTV) ratio, the new appraisal meant that the Huffmans could get $56,000 in cash. However, that amount was reduced to $50,000 after adding in points, origination fees, and other sundry closing costs. The interest rate was 9.5% because the couple was now in a higher risk category.

After paying off their debts, the Huffmans were left with $15,000 in cash. However, they were now stuck with a monthly mortgage payment of $1,177, compared with the $704 they previously paid. This increase hit the Huffmans hard, because they could barely afford $704 a month, no less an additional $473. Their property taxes also went up by $900, since their home was now valued higher. If the Huffmans live within their means and use the remaining $15,000 to pay the difference between the old and new mortgages, they will exhaust the cash in less than three years. After that, they will either lose their home or be forced to refinance again, assuming that their house has appreciated. Since they’re in their mid-40s, the new 30-year mortgage will last until their mid-70s, thus precluding the possibility of retiring at age 67. Without the safety net of home equity, and no other viable resources, the Huffmans are now at the mercy of subprime or predatory lenders.

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