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Bulletproofing your mortgage

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It's tempting to write off all the mortgage bad news -- rising delinquencies, lenders in crisis -- as someone else's problem. After all, the misery seems to be concentrated in loans to the riskiest borrowers.

If you have any kind of mortgage where the payment terms change over time, however, you should be asking yourself: How likely is it that you'll get hit with a big jump in your monthly payment that would mess up your personal finances?

It isn't as far-fetched as it sounds. The exotic loans and more liberal borrowing rules that led to the recent industry troubles aren't limited to people with poor credit or lower incomes.

For instance, adjustable-rate loans offering cheap payments for the first few years are the only thing that enabled some families to stretch and buy the new home they loved, but didn't think they could afford.

Other borrowers yanked equity from one home to buy a second one, or else to invest the money in stocks or a small business. If they used interest-only mortgages (which can require no payments toward principal for years) the payments can spike later.

In the "jumbo loan" category -- which currently refers to most mortgages for $417,000 or more, though it's been lower in years past -- 69 percent of purchases and 63 percent of refinancings were done at adjustable rates in 2004, according to First American LoanPerformance, a mortgage-data company. So now is about when the pain from higher payments is kicking in for many of those borrowers.

The mortgage business has been shaken in the past few weeks. In recent days, for instance, New Century Financial Corp., one of the nation's largest subprime lenders, stopped making new loans altogether.

Oddly, most people pay less attention to their home loan -- likely the biggest debt they'll ever take on -- than they do to their investment portfolio, where the balance is often a lot smaller.

Now is a good time to change that habit, especially if you're in a mortgage of any sort with a payment that can be or has changed.

"We haven't been through a downturn with some of these untested mortgages," says financial planner Elaine Scoggins of Seattle's Merriman Capital Management, who has seen a number of affluent individuals end up in foreclosure over the years.

The easiest out: Switch into a 30-year fixed rate. The national average is currently 6.27 percent, according to consumer-loan data provider HSH Associates. That's low by historical standards, and better than most rates available in the past 18 months.

Here is a set of questions to test whether your mortgage is truly bulletproof. If it isn't, there are ways to get a new one while avoiding key mistakes.

First, a set of old-fashioned financial-planning queries: Are you spending more than 28 percent of your pretax income on mortgage principal and interest payments, plus property taxes and homeowners insurance? Or do these four items, plus all your other debts, add up to more than 36 percent of your gross income?

Mortgage bankers used to deploy these benchmarks religiously. In their zest to issue new loans, however, some have decided it's just fine if the figures are up into the 40s or 50s.

You don't want to go up there for long. After taxes and a 401(k) deposit eat up 30 or 40 percentage points of your income, you'll need money left over for milk and meat and the fridge going on the fritz. And if your mortgage payment is about to spike higher, you'll be that much more vulnerable to unexpected calamities.

Then there's the spouse test. Ask yourself what your significant other would think of the terms of the mortgage if he or she only knew about it.

When Jeffrey Seymour of Triangle Wealth Management in Cary, N.C., sits down with new clients, he often finds that the husband handles the finances -- and hasn't told his wife that the monthly mortgage payment on, say, the beach house, could rise by four figures over the next several years.

The revelation isn't always a happy one. But it can lead to productive conversations. "Frequently they'll have different views on risk, and they might not even know it," Seymour says.

Finally, imagine a confluence of nasty events hitting you all at once. Take, say, a young family in a fixed-rate, interest-only mortgage, where they pay nothing toward principal for years until the monthly payment resets to higher levels. The husband has a solid job, the wife is finishing training for a high-paying career (say, a doctor), and considering all of that, they're comfortable with the higher bills ahead.

Several years later, the couple gets divorced, or she has quit the practice of medicine, or one child is ill -- or perhaps a combination of such events. Suddenly, they can't afford the new payment, they need another dwelling and the value of the house has dropped.

Then what? "Do you have sufficient reserves to ride it out?" asks Christopher Van Slyke of Capital Financial Advisors in La Jolla, Calif. "And if you tightened your belt without reserves, could you make it?"

All of this may seem overly risk-averse, but Van Slyke is merely prudent, not timid. In his own case, he says, back in 1999 when he bought his first house, he financed 100 percent of the $750,000 price tag. But one factor that gave him the confidence to do that was that he knew he would be willing to take in roommates if things really went south. (Everything went fine, and he now lives in a different, bigger house.)

If your own circumstances give you pause when faced with the questions above, it's worth at least shopping for a fixed-rate mortgage that could give you some stability. There are excellent calculators at mtgprofessor.com to help compare your current situation with other options.

Before you research rates, go to myfico.com to buy your credit score, which is the figure that most mortgage lenders consult when considering your creditworthiness.

A FICO score of between 620 and 650 or so is the rough dividing line between prime (good credit) and subprime (more risky) borrowers. Anything above 760 or so (out of 850) probably won't give you a much better rate.

If you're on the lower end, improving your score is especially important, because many lenders who service that market are tightening their standards or getting out of the business altogether.

To get your grade up, pay every bill on time and try to lower any outstanding credit-card debt. Don't open a bunch of new credit-card accounts _ but don't close any either, because the length of your credit history factors into the score.

Once your credit is in shape (it could take as many as 60 days to see results), go shopping. When you find a loan you like, don't sign anything until you understand everything. Incredibly, there are still plenty of smart people getting mixed up in mortgage loans with terms and reset rates that they don't understand.

Your neighbor or friend may have the confidence, financial reserves and mental fortitude to bet on interest rates with adjustable-rate loans. They tell you that fixed-rate loans are for suckers.

But there's no shame in sacrificing square footage or incremental stock-market gains in order to avoid mortgage risk.

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