American homeowners should study their loan documents to make sure that they know their obligations. Otherwise, loans like ARM and interest-only mortgages could blow up in their faces.

Many of the mortgages written within the past decade were complicated, exotic, and highly risky. Homeowners signed documents pledging their homes as collateral for adjustable-rate loans (ARMs) with scheduled interest rate hikes. Some agreed to negative amortization loans, while others signed off on interest-only or hybrid loans that have now backfired. Now that these potentially toxic loans have precipitated a major foreclosure crisis, it's essential that homeowners study their mortgage documents and gain a full understanding of their legal obligations and options.

Tips for understanding home loans

  • Check your mortgage paperwork and most recent account statement. It will indicate how much you owe in principal and interest. Does your loan have a fixed or adjustable rate? See if there's a pre-payment clause in your mortgage agreement; if so, you could be penalized for selling your home and paying the loan off early.
  • If you have an ARM, see what the maximum rate can be at the first adjustment period, and whether the new rate has a cap that limits it from rising beyond a certain level. Some loans, for instance, can rise no more than 2 percent in a single year.
  • Next, figure out which underlying adjustable-rate index your mortgage is tied to. Some go up or down based on what United States treasury bills do, for example, whereas many mortgages react instead to the Libor index, which is based on monetary activity in London. Another is the COFI or cost of funds index. The specific treasury product or index that the loan rate corresponds to can play a significant role in determining how much actual interest you pay.
  • One of the most important documents to hold on to and study is the HUD settlement statement that the lender gives you at closing. This will show a variety of useful information related to the cost basis for your property, and the closing costs and fees. Should you decide to sell your home, this could help you determine your tax gains or losses.

Avoiding foreclosure

Getting your documents together, and reviewing them to make sure that you understand your mortgage terms will help if a problem or question arises. Since foreclosures happen within two to three months after you get behind on a payment, familiarity with your documents, and the ability to find them quickly, could be extremely important if you find yourself in mortgage trouble. Prior planning helps avoid adverse consequences, and also helps you sleep better at night knowing that you have a firm grasp of your mortgage situation.

If you study your documents, and suspect that the mortgage lender has erroneously calculated the amount you owe or is overcharging you for fees, call the lender and complain. Should the problem remain unresolved, refer it to a consumer advocacy group or a real estate attorney.

    Published on November 6, 2008