Ft Worth Star-Telegram The high price of mortgages

Escrow payments and generous appraisals can turn homeownership into a nightmare By JIM FUQUAY and ANDREA JARES STAR-TELEGRAM STAFF WRITERS

For more than a year, Larry and Teresa Light enjoyed their new home in the Holiday Hills subdivision of North Richland Hills. Then came a notice that they were $7,000 behind in their escrow fund used to meet property tax payments.

They had two options to get caught up: Pay the shortage upfront, or stretch the payments out over the coming year. If they paid it all at once, their monthly house payment would rise from $1,240 to about $1,650 to cover the true costs of a year's property taxes. Stretching out the payments meant a monthly house payment of more than $2,100.

"We told them we can't afford either one," said Larry Light, 52. The couple sold their home at a loss and now live in a Bedford duplex owned by Teresa's mother.

The Lights are far from alone in having mortgage problems. Escrow payments are one of several ways in which home buyers can see the American dream of homeownership spin into a financial nightmare, one that often results in foreclosure or at least the sale of the property at a loss.

In Tarrant County, more than 8,500 homes have been scheduled for foreclosure this year, according to Foreclosure Listing Service. That number is up more than 50 percent from three years ago.

The Lights have taken their case to court. They are among more than 70 Tarrant County couples and individuals suing their lender, KB Home Mortgage Co., saying it negligently underestimated the amount of property tax that the homeowners needed to pay into escrow accounts to pay future taxes and insurance premiums.

KB denies the complaints. The case, filed in 2003, is now headed for arbitration.

Underestimating escrow payments seems to be a relatively recent problem. Several advocacy groups that follow mortgage lending issues and other industry experts said it hasn't been on their radar screens.

The issue arises with the purchase of a new home. Typically, the escrow payments are based on the value of the lot, rather than the home and lot. Underestimating escrow on the home has the effect of lowering the borrower's monthly payment, which in turn could allow the purchase of a more expensive home.

"That's an invitation for disaster," said David O'Brien, executive director at Housing Opportunities of Fort Worth, a homeowner-counseling service. The financial hit from a year or more of tax escrow underpayments can be devastating.

In the Lights' case, the couple fell behind on their monthly payments as their loan-servicing company looked at the issue, then sold the home for a $27,000 loss.

Larry Light said that while the couple were getting their loan, the lender's representatives "told us, 'In about a year your tax payments might go up $30 or $40 a month.'"

But that wasn't what happened. After the Lights had been in the house for a year and a half, the servicing company sent them a notice of the escrow shortage.

Olivia Yu, a professor in the College of Public Policy at the University of Texas at San Antonio, found similar examples in a study she and her students conducted of a San Antonio neighborhood with numerous foreclosures. Four of six homeowners who agreed to detailed interviews reported that their beginning tax escrow payments fell far short of what was needed to meet future tax bills.

"First-time home buyers have no sense of taxes," Yu said in an interview. "People blame themselves. They feel stupid. I would, too. But they don't deserve this."

O'Brien said reputable lenders will go overboard in explaining how the mortgage will work and how the taxes will be paid, but homeowners must understand that taxes are not automatically part of the mortgage payment. He also said many borrowers place too much faith in their lenders or real-estate agents rather than enlisting an unbiased third party to advise them.

"Most of the time you are trusting someone you don't know from Adam," he said.

Here are some of the other problems that homeowners have encountered. Owners often have two or three issues with the same loan.

Generous appraisals

Lenders require an appraisal of a house before they agree to make a loan. But an appraisal that overvalues the house can boomerang on the borrower.

Jennifer and Joe, a couple in their late 20s, bought a home in Arlington southwest of Matlock and Sublett roads that they say was appraised at $168,000 when they bought it for $155,000 in 2003. But now, two years later, the home's value is listed as $135,700, according to the Tarrant Appraisal District.

Because they still owe $145,000, the couple are finding it impossible to refinance.

"It's out of the question for us," said Jennifer, a teacher who does not want her last name used because of her family's association with the developer of their subdivision. "VA told us the house would have to appraise at $150,000 to even look at it."

Betty Messman, education coordinator at Consumer Credit Counseling Service in Fort Worth, said overly generous appraisals aren't common but do happen.

"Whenever you're trying to finance not only the house but any type of fees, sometimes they appraise it to take care of all of it in the loan," Messman said.

Bad mortgages

Borrowers who have taken out adjustable-rate mortgages, figuring they would refinance at a fixed rate later, may be in for a nasty surprise.

Jennifer and Joe bought their house with an ARM that started with a 6.35 percent interest rate. This month, their rate will adjust for the first time, going to 9.35 percent. The change will add $250 per month to their house note.

ARMs can be dangerous for several reasons, O'Brien said: Interest rates may go up, the house's value may not rise, and the borrower's credit rating may slip. Any of those factors can make it difficult to refinance an ARM loan, as Jennifer and Joe have discovered.

It's not a small expense, either. A loan rate that rises 6 points, a typical cap on ARMs, can add more than $600 per month to the payment on a $150,000 loan.

Forgetting property taxes

The appraisal on a brand-new home is often based only on the land. Once the home is added, the taxes jump. The house payment can go up even as the value goes down, explains John Marshall, chief appraiser of the Tarrant Appraisal District.

"The other part of the equation is the tax rate," Marshall said. "Normally, they don't appreciate more than 5 or 10 percent, though."

Another KB customer participating in the lawsuit, Ella Gray, moved into her KB-built home in Arlington's South Ridge development in August 2001.

Her mortgage required a tax escrow of just under $50 a month, or about $600 a year. But in 2002, she was notified that her taxes for the year were going up -- to $4,129.37, or $344 a month, according to Tarrant Appraisal District data.

"There was nothing stated that anything was going up," she said. "If they would have said something, people would have prepared for it."

Gray and other homeowners in South Ridge discovered in 2001 that their neighborhood had been used as a practice bombing range decades earlier and was still peppered with tiny unexploded bombs.

The charges, none of which exploded, have been cleaned up but houses in the development have declined sharply in value.

Gray said she moved out of her house this summer after giving up trying to sell it. She said she will lose her $10,000 down payment.

Neglecting escrows

Terry and Nicole Matthews' taxes on their south Arlington home have gone up so much that it's hard to keep up. It's not that they didn't have some room in their budget, Terry Matthews said, but a $4,451 tax bill at Christmastime took a big bite.

That's the bill they got in 2003, which was $1,000 more than the taxes assessed for the previous year. They thought their taxes were being escrowed, but the escrow was only for their insurance premiums.

After they paid the taxes, they set up an escrow, which made their note go to $1,800 a month from $1,400, Terry Matthews said. The next year, the taxes rose to $4,641, according to records. This year the tax bill dropped to $4,208, but not for an encouraging reason. The appraised value of the Matthewses' house has slipped to $137,200 from $154,000 -- a loss of almost $17,000 in one year.

"We're working not for our kids, but for the house," said Terry Matthews, 36.

Part of the Matthewses' quandary is that the house's value has now sunk below what they owe. They can't refinance, and their lender won't make up the difference between the appraisal and the loan. After four years of house payments, they have no equity in the two-story brick house.

"At the end of the day, we're losing more than we're winning," Terry Matthews said.

Borrowing for fees

Lenders often offer to roll transaction fees into the loan or require a small down payment. Both options increase the total amount owed on the house.

That in turn increases the chance that the borrower will owe more than the house is worth, which increases the chance of foreclosure, local housing experts said.

By rolling the closing fees into a mortgage with little down payment, the borrower can be upside down on the house before the first payment.

George Roddy, president of Foreclosure Listing Service, said borrowers are upside down on 15 percent to 20 percent of the homes that go to foreclosure in a typical month.

O'Brien said putting nothing down is a gamble.

"Anyone who goes in with zero percent equity, you are betting that the real estate values are going to go up," he said.

'Help' with down payments

O'Brien said he is seeing more homeowners run into trouble after working with nonprofit groups set up to help with down payments. He said the borrowers don't understand that the money, even though the groups call it a grant, is not a gift but a loan repaid over the duration of the mortgage.

"That's not a grant," O'Brien said. "I get really irked when they call it a grant."

Such a program might be a good fit for a home buyer with a good, stable income who can't come up with a substantial down payment, O'Brien said.

But it could mean trouble for people who have little wiggle room, he said, because they have no equity in the house.

He said the recipients are becoming his office's most common visitors.

"Five years ago, we might see one in a blue moon and now it's probably 50 percent," he said.

PHOTO ILLUS: JUPITERIMAGES