Anyone watching or reading the financial news over the last few weeks has seen a lot of angst and consternation over the state of the mortgage industry. In fact, one of the larger lenders in the US , American Home Mortgage, was forced to shut down operations recently. But why? What is happening, what does all this mean to you and most importantly... what should you be doing do right now to make sure you are protected?

Here's the scoop.

Over the past several years, many loans were made to homeowners with somewhat non-traditional or "non-conforming" situations, be it a poor credit history, inability to document income, or any number of factors that do not fit within the traditional "box" for home loans. These loans are often called "Sub-Prime", or "Alt-A", meaning that they were somewhat riskier in nature than A credit, prime, or traditional loans. Another type of "non-conforming" home loan is one where the credit and income might be perfectly fine, but the loan amount is higher than $417K, which is the current maximum loan that can be done using pools of money from mortgage giants Fannie Mae (FNMA) and Freddie Mac (FHLMC). If the loan amount is higher, it can certainly be done - it's called a "jumbo loan" - but the end money comes from private institutions, not from the large government sponsored entities of Fannie and Freddie.

Most non-conforming loan product rates popped significantly higher recently. Here's what happened.

The end investor for Subprime or Alt-A loans will charge a premium for taking on a pool of these loans, because they know that traditionally, they might have a higher rate of default and delinquent payments within that risky pool. But lately, default and foreclosure has been on the rise - partly due to the fact that with credit tightening and a soft real estate market, many troubled homeowners are unable to refinance or sell in order to get out of trouble. So now, these end institutions are demanding a much higher "risk premium" for taking on these pools of loans, as they see the rates of default are climbing higher.

But since these institutions are purchasing these pools of loans sometimes months after the borrower has actually closed at a given rate, this increase to the risk premium means that instead of paying $101K for a $100K loan that will bear interest, they may only be willing to pay $95K for that $100K mortgage to account for the risk. Multiply that times thousands upon thousands of loans...and you have millions upon millions of dollars in loss for the company trying to sell the pool at a much lower price than they were expecting. This is called a "liquidity crisis", and is exactly what happened to American Home Mortgage - there was no mismanagement, but they simply got caught holding too many "hot potato" loans, forced to sell them at massive losses...and eventually they had to make the decision to close the doors and stop the bleeding.

Further, even when a lender is able to take some losses, they may be subject to a "margin call". This means that as their losses and risk premiums increase, the value of their loan portfolio decreases. As the value decreases, the credit lines that are secured by those portfolios begin to issue margin calls as the value of the asset that they are secured on is now diminished. This is exactly like margin calls in the Stock market. If you have a loan against a Stock that is losing value, you will get a "margin call" and need to pay down the loan, as the underlying Stock is losing too much value to be considered adequate collateral any longer. So for the big lenders, as their portfolio is losing value due to increased risk premiums and losses...the margin calls start coming in, and they are required to pay down their balances. In turn, this means that they have less availability to fund their new loans, which then exacerbates the problem.

In response to seeing this situation play out in the demise of American Home Mortgage, lenders of other non-conforming loan products increased their interest rates dramatically almost overnight to be better prepared - and likely over-prepared - for increased risk premiums down the road. Even though loans above $417K are not presently suffering from increased delinquencies like the Subprime and Alt-A loans are, these rates popped higher as well, because they are being purchased by smaller private entities that can't afford to take on any margin of risk.

What happens next?  The major damage is probably already done, and the present situation will likely settle out over the coming year.  Lenders will stop pulling products off the shelf, and the rates on products that have moved so significantly higher now should trend lower down the road as delinquency rates stabilize.  

But here are a few important things YOU should do right now:

ONE:  Even if you are not presently in the market for a home loan of any type, make sure that your credit standing is as solid as possible. Many people in the market for a home loan didn't expect they would have a need, and didn't plan in advance to ensure their credit would qualify them for the best possible financing. With no immediate need for a home loan, time is on your side... why don't we take a few minutes together and just make sure you are prepared, should a need arise down the road?  Call or email me right away.

TWO:  If you are in the market for a home loan, or know someone who is - understand that now is the time to be working with a real qualified professional who can keep you informed of changes in the market and get your loan funded quickly. Now is NOT the time to be playing the risky game of trying to scour the entire nation to find someone who promises to save you a paltry amount on costs, or deliver a rate that seems too good to be true.

Your home and your financing are just too important, and times have changed. I am here to help and advise during these volatile times - and would welcome calls from you, your friends, family, neighbors or coworkers.

Mistake Number Oneis not aggressively looking for the best deal. Check the interest rates and fees dozens of lenders are offering on various Web sites, such as www.interest.com or www.bankrate.com, which feature comparison of national rates and those in your zip code. Obtain bids from local banks or mortgage brokers. Getting the right loan, at the right interest rate with reasonable fees, can save hundreds of dollars a month and tens of thousands of dollars over the life of  the mortgage.

Mistake Number Twois applying for a loan without checking your credit history for mistakes that make it more difficult to qualify for a loan or that require a higher mortgage interest rate. To get a free credit report from each of the three major credit reporting bureaus go to www.annual creditreport.com. Each credit report shows how to correct mistakes or submit an explanation for legitimate black marks that appear on the report.

Mistake Number Three is spending too much and saddling yourself with payments you cant afford. Avoid that by looking at all of your bills and deciding how much you can comfortably spend. Include a realistic estimate for taxes, insurance and condo or association fees. From that, calculate the amount that could be borrowed at prevailing mortgage interest rates. Add the size of the down payment and that should be the limit. Don't let real estate agents repeatedly show you home outside this price range. Don't work with mortgage brokers who push you to borrow more than you can afford.

Mistake Number Four is not getting preapproved for a loan. This is an important reality check and its free. A lender will look at your credit history , income, savings and debts and them decide on a loan cap. The entire amount doesn't have to be borrowed. But if you can get pre-approved or cant get preapproved for as much as you want to borrow, that a big red flag.

Mistake Number Five is using a dangerous loan to buy a more expensive home than you can afford. Hundreds of thousands of buyers took out interest-only loans or option ARMs because they promised lower monthly payments than other types of mortgages. They were shocked when those payments began going up- sometimes only a month or two after they'd moved in. Now many of those buyers are facing foreclosure. If you can afford the payments on a 30-year fixed rate loan, that's a good sign you're borrowing too much.

Mistake Number Six is agreeing to a pre-payment penalty. More than seven out of every 1- subprime mortgages- those given to borrowers with poor credit- charge thousands of dollars if the loan is paid off in the first several years. That's preventing many borrowers who can't keep up with the rising payments on their adjustable-rate loans from refinancing or selling their homes. Congress and the Federal Reserve are considering whether pre-payment penalties would be banned or restricted in some way. Until then, just tell lenders you don't want a pre-payment penalty in your mortgage.

Mistake Number Seven is taking out "piggy back" loans instead of paying for a private mortgage insurance. If you put less than 20 percent down, you'll have to buy PMI, which protects your lender against default. To get around that, realtors and mortgage brokers often recommend two loans- a primary mortgage for 80 percent of the debt and a home equity loan for the remaining 20 percent. The home equity loan acts as the down payment and negates the need for PMI. That made sense when home equity loans cost less than 5 percent. But with interest rates now averaging more than 8 percent, most buyers will save by getting a single loan and buying PMI. Expect the premiums to be about .5 percent of the outstanding principal, but those payments are tax deductible if the policy is taken out in 2007.

Q: I am desperate to get out of my mortgage, which has increased by more than $500 a month in the last six months. I can't make these payments and have fallen two months behind. Under the criteria outlined for FHASecure, I won't qualify for a refinance. Is there anything else I can do? Are there any other programs that can help me? I am really feeling desperate. I feel like I'm drowning.

A: To recap briefly, FHASecure is a Federal Housing Administration program to help some borrowers who are facing foreclosure because of higher interest rates on their mortgages refinance.

As you mentioned, not everybody qualifies. To be eligible, you must have a good employment history, sufficient income to make the refinanced mortgage payments and a history of on-time mortgage payments before the interest rate reset. The reset must occur between June 2005 and December 2008. You also need at least 3 percent equity in your home and must pay for mortgage insurance. If you don't qualify for a refinance under FHASecure, the first thing you should do is get in touch with your lender! Believe it or not, lenders do not want to foreclose on real estate if there is another alternative. Your lender may be willing to make some kind of accommodation to keep you out of foreclosure.

If your financial problems are temporary- out of work but actively looking with some good prospects, for example- your lender might be willing to accept partial payments, interest payments, etc., for a short time until your financial situation improves. If you can't refinance because of insufficient equity or some other problem, you may be able to persuade your lender to lower the interest rate or extend the loan's term. You might be able to convince your lender to accept a sp-called "short sale", which would avoid foreclosure but require you to give up your home. For example, suppose you have a $300,000 mortgage, but your home, because of declining values, is now worth only $275,000. Your lender might be willing to allow you to sell the home for $275,000 and forgive the rest you owe on the mortgage.

Your lender might also be willing to accept what is known as a "eed in lieu of foreclosure." In this arrangement, the borrower voluntarily deeds the property over to the lender, who then waives the right to sue for the amount still owed. You lose the home but at least you avoid foreclosure and wrecking your credit, not to mention all the accompanying stress. Another possibility might be to persuade your lender to allow you to let a qualified buyer assume the balance of the mortgage. Again, you lose your home but avoid foreclosure.

I don't know whether any of these options might be possible for you, but you won't know unless you get in touch with your lender. Don't be afraid to ask for help!