Friday, January 26, 2007

Credit Card Creep Universal Default 125%

It was one of those extra special Saturdays with a crisp coolness in the air. The sun was shining brightly through the front windshield so much so that the visor had to be lowered. Having left early from his part time job, Travis stopped at a convenience store to pick some beer and food. Three friends were meeting at his house to watch the Notre Dame versus Michigan football game. The wives were coming along later to enjoy a late cook out and to enjoy the newly installed heated spa and pool. Travis and Penny had acted on a promise they had made to themselves when they bought the home four years ago. A primary requirement, beyond the three bedrooms, two baths with a two car garage and large family room, was the need for a large lot that would allow for the construction of a big heated pool and spa. With three children and an active social life this was an important centerpiece of family activities. It was important to complete this mutual promise. It made sense of the hard work and commitment to make this happen.

As a systems engineer at a local company, Travis had not received the anticipated bonuses and pay raises that had been outlined when he hired on right out of school ten years ago. Deciding early on to stay in a smaller city where they grew up and had family with any alternative employment being somewhat limited without a major commute to the nearest active employment center 100 miles away. Penny worked as an outside pharmacy sales representative with one of the big drug companies and ran her regular route between doctor’s offices and clinics. This was the ideal job for Penny as it gave her great flexibility to spend more time with the children who were now all school age. As planned, Travis and Penny had three children in quick order to compress the parenting time into a tighter time frame. When Travis and Penny bought their home the mortgage market was very attractive and they were able to lock up a 5.75% fixed rate on a 30-year mortgage. Travis and Penny justified the expense of putting in the pool by Travis taking a part time job as a security guard at 20 hours per week to meet the payment of the new second mortgage utilized to install the pool and spa. Efforts were made to double the payments of the Home Equity Line of Credit to pay it off early and get down to one payment on the house. That rate was tied to prime and recently had been climbing and the payments were going up. Prime it seemed was going up monthly. Travis and Penny had been very responsible with credit and as a result had good credit scores in the 750 range. Now, with climbing payments on the HELOC Travis and Penny were just able to pay the minimum monthly payment. From time to time, they took advantage of credit card offers as it turns out to a big extent. In a year’s time, they had 12 credit cards with active balances. It just started to creep up on them as they were now just making the minimum payments each month. With their good credit, the credit card rates were good. Travis working the extra time on the part time job some of the bills paying duties were shared with each assuming that the bills were getting handled. In a small alcove of the kitchen was a built in desk area with small cubbyholes and pull out drawers acted as the repository for due bills and the checkbook.

As Travis pulled in the drive way with the goods from the convenience store, as was his practice before unloading, he checked the mailbox. Sure enough he had a fist full of mail. He gathered up the food and beer from the car and carried everything into the kitchen. Upon setting the groceries and such down he headed to the in-kitchen desk to deposit the mail to go over later. However, on top, was a letter from one of their credit card companies. Travis opened it and the communication indicated that they were 30 days late on the credit card payment and that they needed to call immediately to get it handled. Travis and Penny conferred and while ignoring the bagged groceries on the table, began tearing apart the desk looking in all the cubbyholes and crannies, and stuck way in the back crumpled up with another paid invoice was the original bill (now over 30 days late).

Unbeknownst to Travis and Penny, is the “Universal Default” trigger mechanism used by many credit card companies who regularly check your payment history in the bureaus. If they find a 30-day late or other derogatory information the interest rates on ALL the credit cards can be accelerated in many cases to the maximum legal limit. Thus, the sweet heart introductory rates went in some cases from 8.5% to 29.99% to varying degrees. Overnight the minimum monthly credit card payments more than doubled. They were in a real pickle now. The real estate market had pulled back recently and the full value of the pool and spa did not result in a higher appraised value. In looking at their situation, they now had a current balance $165,000 first mortgage at 5.75% with fixed principal and interest payments of $1,021.25/month with little principal pay down since origination.

The taxes and insurance added another $275/month. The second mortgage HELOC was $33,500 with current payments based on prime + at $301.41/month. Then their total monthly housing expense was $1,021.25 + $275 + $301.41 = $1,597.66/month. When they added up the credit card debt it was some $37,500 with an average of 29.99% and minimum payments of now $1,450.00/month. Their total debt was $1,581.69 + $1,450.00= $3,031.69/month. Travis and Penny were stunned. Penny called the mortgage broker who got the original 5.75% purchase money mortgage and shared their pickle and was asking for possible answers short of selling the house or going into a Chapter 13 Wage Earner Bankruptcy Plan. Bob the mortgage broker had worked out a couple of scenarios with one being to sell the house. The market-appraised price didn’t allow for much debt consolidation with the equity available. So Bob suggested either to sell the house or keep the 5.75% first mortgage in place and utilize a 125% Combined Loan To Value (CLTV) mortgage product that would allow the paying off of the HELOC (which had been going up) and payoff all the credit card debt. This would cut all the debt down to two payments one for the first and then the second mortgage. Bob cautioned them that this is not a cure all. Debt relief was being achieved by extending the term of the debt with a rate in the 14.5% range. Bob went on to explain that they were just buying time and that they had to seriously make an effort to make extra payments and get rid of the second mortgage. Although their credit score had dropped the middle score was still above 650. The 125% Combined Loan To Value had a $75,000 maximum loan limitation. Bob proposed paying off the pool loan and all the credit cards with a new loan of $74,900 with closing costs rolled in. The payment on the 125% loan for a rate of 14.5% and a 20-year term would have a payment of $958.71/month. The savings per month then would be $3,031.69/month versus $1,021.25 P&I on the first + $275 for taxes and insurance and the new payment on the 125% CLTV of $958.71/mo. for a total new housing payment of $2,254.96 for a monthly savings of $3,031.69-$2,254.96 = $776.73/month. The Debt To Income Ratio was below 45% a 125% loan program requirement. Bob cautioned them again that while they would have monthly savings the long-term costs could be higher than before so they must commit to cutting costs and stick to a tight budget. Penny committed to making three more calls per day to boost her income. They went ahead and got the relief and made a long commitment to crawl out behind the eight ball and move ahead.