| The
Real Deal on 125% LTV Mortgages
Most
individuals who buy real estate make a down payment (usually between 5%
and 20%) and finance the balance through a lender. For example, a buyer
who makes a 10% down payment on an $80,000 property is essentially
paying $8,000 cash to the seller and is financing the remaining $72,000
(90%). This is referred to as a 90% loan to value (LTV) mortgage because
the mortgage is equal to 90% of the property's value (in this case the
sale price).
There are two primary reasons why lenders prefer to
issue loans with LTVs at less than 100%. The first is that buyers who
make down payments are less likely to walk away from their investments,
in the event of a default. The second is that such loans are more
desirable to major investors who buy them in bundles on the secondary
market. Since lenders are in the business of lending money and
collecting payments, they essentially want to minimize the risk if there
is a default and to maximize the proceeds from a bundled sale.
A 125% LTV mortgage is one that allows an individual
to finance or refinance a property at 25% more than the actual value of
the property. Why would lenders make such loans? Isn't this contrary to
their preference for making loans at 80% or 90% LTV? The answer is yes.
However, lenders are pushing these 125% LTV loans as a new gimmick for
attracting customers in an increasingly competitive market. This is a
risky mortgage program for lenders, but many of them are willing to take
the risks if they can get enough increased business as a result.
The Bait
The 125% LTV mortgages are advertised as a means of debt consolidation,
to enable homeowners to pay off high interest credit card and consumer
debt. These mortgages are also advertised as a way for homeowners to
refinance the debt on their homes, especially if the homes have
multiple, perhaps higher interest, mortgages. In addition, lenders are
inviting homeowners to borrow the extra money to take vacations, to buy
big ticket items, and to pay for education. Quite often, the 125% LTV
mortgages are promoted as tax deductible to further entice the
homeowners.
The Catch
What lenders sometimes fail to clearly disclose is that the 25% portion
of the mortgage that is above the property's value is not tax
deductible. This is because the IRS treats this portion of the mortgage
as unsecured debt. As you well know, you cannot write off any unsecured
debt on your taxes (Remember that the IRS eliminated this benefit
several years ago). The IRS can and will hold homeowners liable for any
penalties and interest, if they are caught taking this unallowed
write-off.
Conclusion
Use your judgment in getting 125% LTV mortgages. Decide whether it makes
sense based on your financial situation. Read the lenders' marketing
literature carefully and contact them with your questions. Review the
cost, terms and conditions, and any applicable restrictions associated
with these mortgages. Then make an informed choice.
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