Affordable Home Loans vs Mortgage Desperation - Part I

by Gerald from Los Angeles, California

Ask Kate about affordable home loans vs mortgage desperation: Fixer upper homes often seem like a bargain for cash-strapped home buyers. But not only do the properties often require major repairs, many borrowers seeking to finance them discover that the only available mortgage programs have sub-optimal terms.


This can set up a vicious cycle of future refinances with high interest rates and costly terms. Case in point, let's meet Gerald from Los Angeles who has already financed a fixer upper he inherited but is running into unexpected zoning issues. On top of that, his interest rate is 10 percent and he has a $325,000 balloon payment in less than 5 years.

In the next Ask Kate letter, we'll hear from Rachel who lives in Knoxville and wants to buy a home that needs renovation in order to quit renting. The obstacle for Rachel is that her family's income is primarily from student loans.

Refinancing Terrible Mortgage Rate and Terms

By Gerald from Los Angeles, California
Refinancing Terrible Mortgage Rate and Terms

Hi Kate,

I have a question about refinancing a terrible mortgage rate and terms.

I am 55 years old and inherited a house that was paid off but needed immediate repairs.

I took out a $325,000 loan with the terms being 10% interest-only for 5 years and a balloon payment at the end of that term. The current home value is $895,000.

My credit score was in the low 600's. I made 12 payments in advance so that I would have some breathing room and the on time payments would help boost my credit score.

My intention was to build a one bedroom apartment over the garage to live in. Then I'd rent out the front house for the going rates in the neighborhood. This would have resulted in a rent free apartment and a positive cash flow after the mortgage, insurance and taxes were paid, with money left for maintenance also.

The property is zoned for this but the city is making it almost impossible to do with a lot of small restrictions such as parking space sizing and such.

I am starting to wonder if I would not be better off using the money that was earmarked for the remodel, to just purchase another small place and still rent out the current property.

I am not working due to some health issues and cannot show an income for the last 4 years due to being my mother's caregiver. I still have over two hundred and fifty thousand dollars in the bank.

Ask Kate at Get-Your-Best-Mortgage-Rate.com
Ask Kate answers: Refinancing Terrible Mortgage Rate and Terms

Hi Gerald,

I can see how Plan A to create cost-free housing for yourself could be a smart move for your future. But I have two concerns... the city-imposed zoning restrictions and the affordability of the existing home loan.

So, the first task at this juncture, I think, is to figure out whether you are going to be able to comply with zoning requirements. Otherwise, you are spinning your wheels.

Then, if there is a way to meet the zoning requirements, you'll need to determine if the cost is affordable. Think Money Pit! You don't want to get trapped in a vicious cycle of pouring money into a project that drains your resources.

Or instead, let's say you decide to pursue Plan B. You buy a small home instead of building an apartment for yourself and rent out the house you inherited.

But wait! Doesn't the inherited house need repairs before you can rent it? If so, set aside a portion of the refinance proceeds for repairs before spending it all on a home for yourself.

Consider Mortgage Affordability vs Mortgage Approval

Whichever plan you choose, develop a budget that details income (that you know you can depend on) and expenses, including mortgage payments, projected upkeep on the dwellings, and personal living expenses.

And by the way, it's impossible for your mortgage originator and/or underwriter to calculate how much you can afford in a house. So don't get trapped into thinking if you are approved for a mortgage that surely you can afford it. Learn how to protect your future at How Much Can You Afford in a House.

Prepare for Rental Vacancies - Keep Money in Reserve

Additionally, rental houses often go vacant, even in the best markets. So set aside sufficient funds to pay for the mortgage, upkeep, and unexpected repairs during the inevitable times that you are in-between renters.
Learn from the investor living in San Francisco who says he caught his leg in a real estate bear trap at Gluttonous HARP 2 Mortgage Closing Costs.

Break Out of the Balloon Payment Cycle

Lastly and perhaps most important, create a viable plan to satisfy the balloon payment of $325,000 that you are obligated to pay in the next five years. If there is anything we learned as borrowers during the collapse of the real estate market, it's this. Houses go up and down in value.
Tina S from Coatesville, PA writes that she is $25,000 behind on her mortgage with a $157,000 balloon payment and isn't sure if it's worth trying to save her home. Read her story at Trapped in a Balloon Payment Mortgage.
So do not depend on being able to refinance into a superior mortgage to bail out of the balloon payment. Five years comes quickly and if you aren't prepared, you could find yourself in a cycle of desperation, putting yourself at the mercy of the lender who might be more than happy to continue dishing out 10% interest-only mortgages with balloon payments in 5 years. This is a sure way to invite foreclosure.

I like your plan to create income from a rental property that pays for a personal home. But I urge you to consider the long-term affordability factor before diving in any deeper.
You'll also want to read Cash Out Mortgage Refinance: Mother in Law Unit to see what I told Maria in Bakersfield, CA who is considering a plan similar to yours.
Best wishes,

Ask Kate
P.S. You just finished reading the first Ask Kate letter in a mini series on affordable home loans. Now go to Affordable Home Loans: Fixer Upper Houses - Part II for the second post in the series.

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