“In skating over thin ice our safety is in our speed.” — Ralph Waldo Emerson

Much has been written of late about lenders, homeowners and sub-prime loans. TIME magazine provided A Sub-Prime Primer on why this is such a big issue: “A wave of defaults on ‘subprime,’ or high-risk, home mortgages has not only rocked the Dow; it also threatens to ripple through the economy.” Here’s how:

1. When Homeowners Can’t Pay…
“Borrowers with poor credit and unusual loans have often taken on more debt than they can handle. And if rates rise, they are vulnerable to default and even foreclosure.”

2. Mortgage Lenders Get Hammered…
“Many lenders resell their high-risk mortgages to investment banks. If defaults rise, the lenders are often forced to buy back the bad loans, which hurts earnings and stock prices.”

3. Investment Banks Lose Business…
“The firms that buy the loans usually repackage them and sell them as securities (for a profit, of course). As securities get riskier, there are fewer buyers. That means lower profits.”

4. Institutional Investors Are Exposed…
“Banks, hedge funds, insurers and mutual funds have been buying the risky bonds because they promise high rates of return. As defaults spread, that promise evaporates.”

5. And They Flee the Stock Market
“The mortgage storm plus slowing consumer spending lead investors to look for safer bets than stocks. Another fear: tighter credit further weakens the housing market.”

Gretchen Morgenson at The New York Times agrees that tighter credit will further weaken the housing market and warns that Crisis Looms in Market for Mortgages. She noted a paper published last month by Josh Rosner and Joseph R. Mason assessing the potential problems associated with disruptions in the mortgage securities market. The authors said, “Decreased funding for residential mortgage-backed securities could set off a downward spiral in credit availability that can deprive individuals of home ownership and substantially hurt the U.S. economy.”

That’s bad news for those trying to buy and finance a home today and in the future, but what about the millions of people who are in over their head with sub-prime loans. The Mortgage Professor has an excellent tutorial on “What is a Sub-Prime Mortgage Lender?” and defines both the sub-prime lender, borrower, the 2/28 ARM and why prime borrowers often find themselves in sub-prime loans.

By the way, the Mortgage Professor isn’t just some guy dishing out his opinion on the Internet; he is Jack M. Guttentag, Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. You should bookmark his site and refer to it before you finance or refinance any real estate.

Moving on… what happens if you are a homeowner at risk or worse, you have gotten behind on your mortgage payments? Sandra Block at the USA TODAY explains how Foreclosure Hurts Long after Home’s Gone. She suggests taking action and cutting a deal while you can. Don’t wait until it’s too late.

I’ve written in the past about preventing foreclosure in Dial the Lender. Last August, Noelle Knox also reported in the USA TODAY that, “Almost 280,000 Americans lost their homes through foreclosure last year. But that’s not the surprising part. This is: Half of them never even talked to their lenders.”

Now, less than a year later, Block writes, “More than 2.1 million Americans with home loans missed at least one payment last year, according to the Mortgage Bankers Association. Even more troubling, the rate of new foreclosures hit a record.”

Block continues with tips to avoid default and suggests, “If you’re suffering a temporary financial setback, your lender may offer programs that will help you get back on track. They include:

  • Forbearance. This is an agreement that lets borrowers make a reduced payment, or none, for a specific period. You might have to make larger payments once the crisis has passed. To qualify, you might need to show that you’re expecting a bonus, a tax refund or other income that will let you catch up.
  • Reinstatement. You agree to pay the full amount of your missed payments by a specific date. Reinstatement is sometimes combined with forbearance.
  • Modification. Your lender agrees to change the terms of the loan to make payments more affordable. Your lender may agree to add missed payments to your loan balance or extend the term of your loan, reducing the size of your payments.”

She concludes with what to do if your financial setback isn’t temporary and you’re really in a home that you can’t afford, then it’s time to move in order to avoid foreclosure. She suggests these three options:

  • “Put your home up for sale. This may be the best choice if you’ve been in your home for several years and have built up some equity.”
  • “If you have no equity or your local real estate market is depressed, ask your lender to consider a ‘short sale.’ In a short sale, the lender agrees to accept the proceeds from the sale of your home, even if they don’t cover the amount you owe.”
  • “Ask your lender to accept a deed in lieu of foreclosure. If you can’t sell, your lender may agree to take the deed to your home and cancel your debt.”

In some states, the foreclosure process begins as soon as you have missed just one payment. It’s important not to ignore things and take action with your lender at the first sign of trouble.