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Risk of Debt Leveraging in Buying a Home

Rathin Neogy, MBA

In the U.S. and Canada, one often hears about the importance of debt leveraging in the acquisition of real estate property. With borrowing having become easy in today’s market given the competition among institutions, more and more lenders are offering home loans without asking for “income verification” or “stated income.”

This now makes it possible to borrow more money than if one went to a lender who requires information on earnings and expenses for approving a loan.

Risk of Debt Leveraging in Buying a Home Thus, in markets where the housing affordability index is low, two-income couples are now able to purchase a home without much fuss. Also, once the value of your home appreciates, lenders come after you to refinance your home and take money out. This is where a lot of American families get into trouble. It is alright to take some of your equity out and re-invest it wisely. However, with the temptation of improving one’s lifestyle, more and more families are spending their money unwisely by buying non-essential luxuries, expensive vacations, etc.

In most of these cases, the couple is still able to survive as long as both continue to work and maintain their employment status. The problem begins when one member loses his or her job? If you have high debt leveraging, your problem becomes potentially more serious! All of a sudden, the couple finds it difficult to pay their mortgage payments. Initially, with their good credit, they still may be able to borrow even more by getting, for example, a home equity or other type of personal loan. This may keep them going for a while. But, after a few months, when they start having problems servicing their increased debt, they start becoming delinquent on their high ticket items such as their mortgage payments.

In many markets, the consumer is still not threatened with foreclosure. Property values appreciate allowing the consumer to refinance their homes by equity cushioning that usually prevents the loss of property due to loan default. In some cases the borrowers can avert a problem by quickly selling their home and paying off their indebtedness. In most cases, however, a homeowner hopes that their financial problem is temporary and that they somehow would be able to hold on to their home.

But the important fact about our economy is that it cyclical. A period of growth for a few years is inevitably followed by a recession when jobs are lost and, if you are overstretched financially, you seriously risk losing your home through foreclosure.

Specific steps are followed before your lender can legally foreclose and knowing this is the first step in preventing foreclosure and seriously damaging your credit. A few months after the loan has gone into default — sometimes several months — the lender issues a notice of default (NOD), which is recorded against your property in the county where you reside. You are allowed a reinstatement period, usually of three months, to bring the loan current by paying arrears, lender’s costs and expenses. On lapse of this grace period, the lender issues a notice of trustee’s sale, which informs the borrower the date the property will be sold in auction. At this point, you can still stop the foreclosure if you can pay off the entire balance of loan plus foreclosure costs within the last five business days before the trustee’s sale.

Long before you reach the point where a lender issues a notice of trustee's sale, you need to take aggressive action. After receiving a NOD, the first step to take is to decide whether to sell your property. Once you make the decision to sell your home, it is very prudent to employ a good realtor who can find the best way to sell quickly. An experienced agent will also appreciate the need of not just getting offers but finding well qualified buyers who can close escrow as quickly as possible. So select an agent who agrees to a short-listing agreement. This way he will be motivated to work aggressively in marketing your home. You may also consider raising your agent’s commission. Be sure to also enter into a contract with your agent that you have the right to terminate the contract, with a 7 to 10 days written notice, if you feel the agent is not effectively marketing your home.

Finally, in conclusion, it is generally a good thing to use debt leveraging when you own your home. Make sure, however, that you do not overextend yourself in case of downturns in the market. A good rule—of—thumb is to always have at least six months worth of liquid assets to help you tide over unexpected setbacks.

(The author is a Broker—Associate with the Sterling Real Estate company in San Diego, California. He has been practicing real estate since 1997.)

Disclaimer: The opinions expressed in this article are solely those of the author and do not represent those of the Sterling Real Estate company.

The article is written by:

Rathin Neogy, MBA
The Sterling Real Estate Company

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