Another day, another buyer getting roped into a loan he or she shouldn’t have.

In the past few weeks, I have received several letters from readers who are considering getting mortgages with severe prepayment penalties attached to them.

One borrower was offered a four-year prepayment penalty, known as a 4-3-2-1. That means if he sells or refinances in the first year, he’ll pay a 4 percent prepayment penalty on the loan. In the second year, he’ll pay 3 percent; 2 percent in the third year; and 1 percent in the fourth year.

He needed a $250,000 loan, which means if he refinances or sells in the first year of the loan, he’ll pay $10,000. If you add in closing costs, a broker’s commission and other expenses, his property will need to increase about 15 percent in value in the first year just to break even. Otherwise, a good chunk of his equity in the property will evaporate.

And what’s he getting for taking on this risky kind of loan? A savings of a quarter percent in the interest rate. He’ll save about $100 per month.

But that loan is better than the one another elderly reader of mine wrote about. She was offered a loan with a three-year, 4 percent prepayment penalty. In other words, if she sold her home or refinanced anytime over the course of the first three years of the loan, she’d pay 4 percent.

On a $250,000 loan, that’s $30,000 — even if you close one day before the prepayment penalty period expires.

If you think no one is being offered loans like this, think again. It isn’t just subprime lenders who offer prepayment penalties. Like a hook with bait, conventional lenders use prepayment penalties to reel in prized borrowers — those with great credit scores.

In exchange for a quarter-point dip in the interest rate, these folks are on the hook for two to four years. Landing that kind of fish puts a lot of chips in the mortgage lender’s wallet.

It’s clear that many borrowers don’t understand what prepayment penalties are and why they’re so bad. Or, they think that after a year or two, the penalty period will expire — but they don’t take the time to read the paperwork or the multiple disclosures they sign at the closing table.

Here’s the sorry truth: While prepayment penalties are prohibited by many states, they’re permitted by federally chartered lenders. Who is a federally chartered lender? Any lender that has established its charter not in any one state but as a federal savings bank or under federal laws. Think of your major mortgage lenders, most online lenders and local banks that have chosen to organize under a federal charter. It’s an end-run around consumer-protection laws put forth by the states.

If you’re considering getting a home loan that has a prepayment penalty attached, here’s what you need to know: A prepayment penalty means that you cannot sell your home or refinance within the penalty period without getting penalized. That penalty can be thousands of dollars. It can even mean that you might owe money to the bank above and beyond the sales price for the home.

There are no “ifs, ands or buts.” Your lender won’t care if you get a job transfer, if your child gets sick, or you die. (If you die, your estate will have to pay the prepayment penalty out of the closing proceeds.)

You can still make extra payments toward the balance of the loan, but sometimes the amount of these prepayments is limited — you’ve got to read the pesky fine print.

The worst part about prepayment penalties is that they’re often associated with predatory lenders, lenders who are trying to catch you in a no-win situation with spiraling interest rates and no way out without forking over a huge cash payment.

I’d rather see you do almost anything than get a loan with a prepayment penalty. Know this: If you sign up for a loan that has a prepayment penalty period, you’ve just cut your financial options to one.

Recently I received an email from a reader who asked if having a tall water tower about 1,000 feet from his house would hurt his home’s market value. By coincidence, a few days later I saw an appraiser friend at the local post office so I confronted him with that question.

“It sure won’t help a home’s market value,” was his reply. Then, being an experienced appraiser, he reminded me the water tower is called “functional obsolescence.” That means it is a material fact that is virtually impossible to eliminate but has a significant impact on market value.

Functional obsolescence factors, whether within the property or outside, should always be considered when buying a home. Sometimes they “kill the sale.” But in other situations, the buyer doesn’t care or even likes the problem, which other buyers loathe.

For example, years ago I owned a rental house where the backyard adjoined a school playground. Although the house was in excellent condition, when prospective tenants spotted the playground hidden behind bushes, they suddenly lost interest. I quickly learned to advertise that house as “Close to elementary school.” Then I had no trouble renting to families with children.

Looking back, I now realize that house adjoining the noisy school playground was a “bad house.” It had an incurable defect that most prospective buyers and tenants disliked, thus affecting its desirability and market value.

EVEN NEW HOUSES HAVE DEFECTS. Fortunately, most on-site problems with new houses are correctable, such as paint scratches or doors that don’t close right. Buyers of new houses should (a) understand the terms of the builder’s warranty; (b) hire a professional inspector to thoroughly check the house before the sale closes; and (c) inspect the house with the builder (called checking a “punch list”) so both parties are aware of problems needing correction under the builder’s warranty. Realizing the importance of having satisfied customers, the best builders promptly take care of any defects reported by the buyers.

THE DUTY OF HOME SELLERS TO DISCLOSE DEFECTS. Most states now have either statutes or precedent court decisions that require home sellers and their real estate agents to disclose, in writing, known defects with the residence. However, some sellers and realty agents have “selective memory,” meaning they forget to reveal some defects, hoping the buyers won’t discover them.

When a home buyer can prove the seller and/or realty agent knew or should have known about a home defect, the buyer’s legal recourse is to either (a) seek rescission of the sale or (b) sue for monetary damages. However, the buyer’s difficulty is proving the defect was known before the sale closed.

PROFESSIONAL HOME INSPECTORS AREN’T PERFECT. In addition to obtaining a written home-defect disclosure report, even when a home is being purchased “as is” (meaning the seller won’t pay for any repairs), smart buyers insist their purchase offer include a contingency clause for their approval of a professional home inspector’s report.

When hiring a professional home inspector, be sure to inquire as to the inspector’s experience. Personally, I prefer members of the American Society of Home Inspectors (ASHI) because of their high membership standards. Local ASHI members can be found at www.ashi.com or 1-800-743-2744.

Home buyers should always accompany their professional inspectors. In addition, the realty agents and the seller are welcome to attend, just in case an unexpected serious defect is discovered and needs to be discussed.

When a serious undisclosed defect is found by the inspector and the buyer still wants to buy the house, a smart buyer will use the inspector’s report to (a) get the seller to pay for repairs; (b) reopen negotiations with the home seller to get a repair credit, or (c) go ahead with the purchase anyway, knowing of the defect, even if the seller won’t offer any compensation.

DON’T BE FOOLED BY HOME-WARRANTY POLICIES. Home sellers and their realty agents often buy, as a sales inducement, a one-year home-warranty policy. These policies pay for repairs to built-in appliances, plumbing, wiring, furnace, and the hot water heater. Often excluded, unless an extra premium is paid, from warranty coverage are the air conditioning, plumbing outside the home’s perimeter, roof, foundation and structure.

Home buyers should be aware warranty companies charge about $50 per service call, even if the defective component isn’t covered by the policy. A favorite ploy of many home-warranty companies, especially when the problem is very expensive to repair or replace, is to say the defect was a “pre-existing condition,” which is not covered by the policy. The best place to resolve such conflicts is in the local Small Claims Court where the home buyer usually is favored by the judge.

THE “TOP 10″ STEPS TO AVOID BUYING A “BAD HOUSE.” Although most professional home inspectors have these key factors on their checklists, savvy home buyers also should be on the lookout for these potential serious problems:

1. MOLD AND MOISTURE. Even the best homes, at one time or another, have mold or mildew. The cause is trapped moisture, usually due to poor ventilation. In excessive amounts, such as after a flood or water pipe break, it can ruin a home because mold can be extremely difficult or impossible to remove.

2. RADON. According to the Environmental Protection Agency, this naturally occurring, radioactive gas is created in soil and rock beneath 1 in 15 U.S. homes. Radon allegedly causes cancer in residents whose homes contain radon underneath.

3. ASBESTOS. Asbestos was routinely installed in millions of U.S. homes for fireproofing, insulation, roof shingles, and floor tile. In good condition, there is nothing harmful about asbestos. However, when it deteriorates and the particles become airborne, asbestos can cause fatal lung disease.

4. LEAD-BASED PAINT. Before 1978, lead-based paint was used in most homes. It can cause brain damage to young children who ingest it, usually from flaking paint chips. But it is not dangerous if the paint is in good condition.

Federal law requires sellers of homes built before 1978 to provide home buyers and tenants with (a) a federal booklet about lead-based paint dangers, and (b) a disclosure form if the seller or landlord had lead-based paint tests performed. If desired, home buyers have 10 days to have a lead-based paint inspection at the buyer’s expense.

5. FORMALDEHYDE. Many manufactured homes contain this material which causes eye, nose, and throat irritation, as well as coughing, rashes, headaches and dizziness in some people.

6. CARBON MONOXIDE. Malfunctioning furnaces, wood stoves, kerosene heaters and lamps, fireplaces, water heaters, and gas stoves can produce invisible but deadly carbon monoxide in homes. The easy solution is to install a carbon monoxide detector, usually costing $25 to $40.

7. DEFECTIVE WELL WATER. If the home being purchased depends on well water, be sure to include a purchase-offer contingency clause for a test of the well-water quality. Also, have the well’s pump tested to be certain it is in good working condition.

8. SEPTIC OR SEWER SYSTEM. A home that is not connected to a public sewer system probably has a septic system, which drains waste water into the soil. Be sure the septic system is located a substantial distance from any well. If the seller reports the home is connected to the public sewer, be sure to verify this and that the sewer pipe is not broken.

9. HIGH-VOLTAGE POWER LINES. Government tests have been inconclusive if adjacent high-voltage power lines cause cancer and other diseases. But they certainly don’t benefit health. The presence of nearby high-voltage power lines won’t enhance a home’s market value and can be considered a serious negative factor at resale time.

10. OTHER NEGATIVE INFLUENCES. There are many possible negative influences, sometimes beyond the home’s lot boundary, that can affect desirability. Examples include a high crime rate, heavy street traffic, poor location, poor-quality public schools, lack of public transportation, nearby noisy railroad tracks, poor floor plan, inadequate or dangerous wiring, galvanized pipes, an old furnace, leaky gutters, flood zone, high fire-hazard area, earthquake fault zone, seismic hazard zone, easements and encroachments and high property taxes.

SUMMARY: No house is perfect. To avoid buying a “bad house,” smart home buyers ask lots of questions and insist on a professional home-inspection contingency clause.

When a 3,100-acre wildfire roared through the southern end of Lake Tahoe, Calif., last June, residents were instructed to evacuate the area. “My house was about a half mile from the fire,” said Fredy Buraye, the owner of a three-bedroom vacation home in the area. “It was pretty close.” Mr. Buraye said his anxiety about losing his home was slightly quelled because he knew he was adequately prepared for the situation. “I knew I had the right insurance coverage.” Mr. Buraye said he was lucky; the fire never made it to his home.

While securing insurance is a fact of homeownership, lining up coverage on a vacation home is not always a straightforward process. Vacation homes can be expensive to insure and some companies will not offer coverage if the home is regularly rented out. And when owners do find insurance, they may have to pay extra for extended liability or coverage that will protect the home in case of a flood.

GETTING STARTED

The best time to start thinking about insurance is before closing on a property. “The reality is that a lot of what makes vacation homes appealing are the same reasons that can make them expensive or difficult to insure,” said Jean Salvatore, a spokeswoman for the Insurance Information Institute. A house in a gated community close to a fire station would likely be less expensive to insure than a home that is in a remote location. And homes along the east coast, a flood prone area, have also become increasingly expensive to insure.

RESEARCH INSURANCE CARRIERS

Your primary insurer is a good place to start because of the established relationship: the process will be more seamless, and insurance providers may offer the best rate for owners who insure all of their property and cars under one provider. Although there could be drawbacks to that if an incident leads to the cancellation of all the insurance, leaving the holder widely exposed. If your insurance company will not cover a vacation residence, turn to local providers in the area of your second home. Be prepared to answer questions about how often the home will be used, if it will be used as a rental and who will be responsible for managing the property.

SECURING LIABILITY COVERAGE

For owners who rent out their properties — even for just a lucrative month in the summer — securing the proper liability coverage will help protect assets in a lawsuit.

Cindy Pieper, the owner of State Farm Insurance in Palm Springs, Calif., works with second homeowners buying retreats in the southern Californian desert. She recommends a minimum of $1 million dollars in liability coverage and encourages owners to take out personal umbrella liability coverage reflecting an owner’s total net worth. Those policies typically start at $300 a year for the first million dollars and $150 a year for each additional million dollars worth of coverage.

INSURING A CONDO

A condo insurance policy will cover the interior of the unit and personal property in the residence in case of, say, a fire or smoke damage, since most homeowners’ association coverage does not extend to the interior of a dwelling. Condo owners may also want to add what is called loss assessment coverage to their policy, according to the Insurance Information Institute. This can help cover a large assessment issued by the condo association. Owners renting out their property may also consider a policy that covers loss of rental income if the dwelling is damaged, says insurance industry agents.

OTHER FACTORS TO CONSIDER

A house with a swimming pool is seen as a higher risk, and a house with a pool that is not protected with a fence and locked gate will not get any coverage. Risk of wildfire can also push up premiums or make coverage difficult to obtain if the house does not have easy access to a local fire department, according to State Farm Insurance and the Insurance Information Institute.

If a property is in a flood zone, most banks will require flood insurance as a condition of the mortgage, according to most insurance agents.

Flood policies are available through your insurance agent but are actually backed by the National Flood Insurance Program. Policies run anywhere from $1,100 to $1,800 in coastal areas and as low as $600 a year in non-coastal communities.

KEEPING POLICIES UP TO DATE

Any improvements made to a home — from adding a new bathroom to building out a deck — is a reason to call your insurance agent; so is redecorating the interior or purchasing kayaks and new bikes for the family.

Mitch Jawitz, a vice president at The Hartford, an insurance provider, said to keep a running inventory of belongings in the house and review coverage once a year because, “You may need to purchase more insurance.”

Loans entered the foreclosure process at a record rate during the fourth quarter, and things are likely to get worse before they get better, the chief economist for the Mortgage Bankers Association said today.

Although reductions in short-term interest rates have lessened the shock of interest-rate resets for many borrowers with adjustable-rate mortgage (ARM) loans, falling home prices are leaving more homeowners with little or no equity in their homes — and less incentive to keep up on their mortgage payments, said MBA Chief Economist Doug Duncan.

That’s particularly the case in states such as California, Florida, Nevada and Arizona, where overbuilding created surplus inventories that will take some time to work through, Duncan said.

The rate of foreclosure starts in Florida more than tripled between the fourth quarter of 2006 and the fourth quarter of 2007, and more than doubled in California.

Nationwide, the rate of loans entering the foreclosure process hit a never-before-seen 0.83 percent during the fourth quarter, up from 0.54 percent a year ago and 0.78 percent in the third quarter.

That pushed the total percentage of loans in the foreclosure process, which stood at 1.19 percent at the end of 2006, to 2.04 percent in the fourth quarter 2007 — also a new record.

The delinquency rate rose to 5.82 percent during the fourth quarter — the highest the MBA has seen in its quarterly survey of lenders since 1985. The delinquency rate stood at 4.95 percent during the same quarter a year ago, and at 5.59 percent in the previous quarter.

“Our general outlook is as long as house prices are declining, we expect to see some continued increase in delinquencies and foreclosures,” Duncan said. With the continued seizure of credit markets and tightened underwriting standards, “we don’t expect to see the peak (in foreclosures) until mid- to late-2008.”

If there’s any good news in the latest numbers, it’s that there’s been little growth in the rate of foreclosure starts in Midwestern rust-belt states such as Michigan, Ohio and Indiana, where different factors are in play. Job losses and outmigration, rather than overbuilding, have contributed to the decline in demand in those states, Duncan said.

Duncan said the nationwide increase in foreclosure starts was due to increases in both prime and subprime loans, with adjustable-rate mortgages (ARMs) of both types accounting for 62 percent of foreclosure starts.

Since the fourth quarter of 2006, the foreclosure start rate for prime ARMs increased from 0.41 percent to 1.06 percent, while the rate for subprime ARMs increased from 2.7 percent to 5.29 percent.

Subprime ARMs represented just 7 percent of loans outstanding, but accounted for 42 percent of foreclosures starts during the fourth quarter. Prime ARMs represented 15 percent of outstanding loans, and 20 percent of the foreclosures started.

While millions of ARM borrowers still face interest-rate resets, Duncan said the impact of those payment adjustments will be less than feared because cuts in short-term interest rates made by the Federal Reserve have also brought down the six-month LIBOR rate, the index used for many subprime ARM loans, by 2.5 percent since last September.

Duncan said the MBA forecasts at least one more cut in the federal funds rate this month.

“The reduction in LIBOR will mean that the resets of those loans will bring them very close to current contract rates,” Duncan said. The problem of payment shock “will be much less than thought, although it won’t be ameliorated.”

If rising delinquencies and foreclosures were once believed to be largely confined to subprime loans, those days are past. The MBA survey showed prime loans accounted for 38 percent of foreclosure starts, compared with 50 percent for subprime loans. Prime loans made up a much larger percentage of outstanding loans, however — about eight in 10.

Number 10

I can’t make my house payments, but I do have an ability to pay back all or part of the negative equity. Also, I want to preserve my credit score…is a short sale right for me?

Probably, not. In cases where the seller can pay back all or part of the negative equity (usually to the 2nd lien holder), it makes sense for them to work out a repayment plan. The lender will then release the lien and allow the home to close.

Number 9

If I pay mortgage insurance and default on my loan, why wouldn’t that cover the deficiency amount?

The mortgage insurance is not there for your protection, just the mortgage lender’s.

Number 8

Do I have to have my home “Approved” by the lender prior to offering it for sale as a short sale?

No. Technically speaking there is no such thing as being “Short Sale Approved.” The actual approval only happens with an accepted offer.

Number 7

I just missed a payment and I know I will miss more…how long does the foreclosure process take and is there time to do a short sale?

The foreclosure process takes differing times depending on your state.  In the Midwest a foreclosure can take over a year. In California its taking 6+ months.  Generally speaking a well priced short sale being processed by an educated short sale listing agent will sell and close in less than 120 days.

Number 6

Will I still have to pay property taxes if I do a short sale?

Property taxes will always have to be paid as part of any accepted short sale. Whether it’s you or the lender, it depends on their policies and the specific agreement you reach while negotiating the short sale.

Number 5

I owe more than my home is worth and I can’t make the payment. Do I have to somehow qualify for a short sale?

The simple answer is NO. If someone can’t make their payment and they are otherwise insolvent, they qualify for a short sale. Note: insolvent simply means their total debts are great than their assets.

Number 4

Do I have to pay income taxes…I have heard that I will get a 1099. Will the loss the bank takes be treated as a taxable gain to me…the seller…is this true?

It WAS true, now it’s not. Consult your Tax Attorney or Qualified CPA.  Very recently the tax law was modified and now most people who do a short sale will have no taxes due.

Number 3

How do you, my listing agent get paid…who pays your commission?

The bank will pay the commission along with all the other usual closing costs.

Number 2

Do I have to miss a payment to do a Short Sale?

No. Late last year most major lenders started accepting short sale offers from sellers who have never missed a payment.

Number 1

I want to do a short sale and have a 2nd mortgage, does this make me ineligible?

No. Both of your lenders will need to be satisfied in some way to complete the short sale. If your first lender will be paid off by the sale, then you just negotiate the terms with the second lender. Most short sales do involve 1st and 2nd lien holders.

WASHINGTON — In a market where houses are taking longer to sell — or not selling at all — owners hoping to move on sometimes opt to rent their homes until things improve.

The popular wisdom among real-estate professionals is that this is a sensible solution. That way, you can at least generate some cash flow from your idle property and take advantage of sagging house prices and relatively low mortgage rates in buying your next place. FOR THE RECORD:
Tax break: The Housing Scene column in the March 16 Real Estate section incorrectly reported that the capital-gain exclusion on the sale of a primary residence is a once-in-a-lifetime benefit. If all other criteria are met, this exclusion applies any time a primary residence is sold. —

Renting out your idle house is a good idea, realty pros say, even if you must borrow against it to have enough money for a down payment on your new one. For the pros, the positives outweigh the negatives when it comes to renting versus waiting.

But not always.

For example, if the for-sale market takes longer to improve than some experts predict, you might miss out on the once-in-a-lifetime, $500,000 capital-gains ($250,000 for single taxpayers) exclusion.

Indeed, the consensus seems to be that you’d better be ready to act as a landlord for more than a year.

Eileen Landau of Realty Executives in Naperville, Ill., recommends renting over sitting. That way, she said, homeowners generate some income and can “get on with their lives.”

Nowadays, you can claim the one-time capital-gains exclusion only if you live in the house for two of the last five years. So that gives you a three-year window. If you rent for longer than that, you’ll lose a very valuable write-off because the house will no longer be your principal residence.

Just be aware: Landlording is not for amateurs.

Another issue to consider is fix-up costs.

Rob Massey of rentals.com says making a home ready for lease is strikingly similar to preparing it for sale. When the tenants move out, whatever fix-up costs you incur will be deductible as either rental or sales expenses.

“Yes, it will cost some money” to make the same improvements twice, Landau says. “But it is much better than paying out on an empty house.”

There are drawbacks to leaving a house unoccupied. A vacant home is a prime target for thieves, vandals, even squatters.

Selling an empty house presents its own challenges. One option is to “stage” an otherwise empty house with rented furniture. However, unless your real-estate agent can supply the necessary pieces, that’s an additional expense — one you may not want to incur on top of a mortgage and other carrying costs.

If renting is your choice, and you want to keep the place on the market, make sure you sign “cooperative” tenants who agree in advance to show the house at a moment’s notice and to keep the place in “show ready” condition. The lease should clearly state the requirements. Some owners discount the rent for this cooperation.

This, of course, also requires short-term tenants who are prepared to move if and when the house is sold.

“Have them move into a house listed for sale at a below-market rental rate as a trade-off to keep the home clean and show ready at the drop of a hat,” suggests Wendy Frenzel of A Vantage Properties in Denver. Another possibility is a house-sitting company. These businesses screen “the sitter and their furniture.”

In return for an under-market rent, the sitter agrees to keep the property in show-ready shape and move out with two weeks’ notice.

If none of this appeals to you, and you don’t want to wait until the housing market improves, you just might want to follow the advice of Al Napier of the Napier Realty Group in Newington, Conn., who says you should “bite the bullet” by taking whatever you can get and move on.

Unless sellers want to become professional investors, they “should absolutely not rent out their properties or leave them vacant for any length of time,” Napier argues. “Instead, they should do whatever is necessary to sell their place within the constraints of the marketplace and get it over with.”