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Last Updated: May 14th, 2012 - 22:24:01 |
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Most individuals who buy real estate properties 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%) in the form of a mortgage. 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 reason is that buyers who make down payments are less likely to walk away from their investments, in the event of a default.
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The second reason 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 more competitive market. Yes, 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 being heavily advertised as a means of debt consolidation. They are billed as low cost debt that homeowners can use to pay off their high interest credit card and consumer debt. They are also billed 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, who are caught taking this unallowed write-off, liable for any penalties and interest.
Note that the IRS is keeping close watch on this banking practice in light of the potential problems.
Conclusion
Use your judgement 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.
Source: Forclose.com
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