01:00 AM EST on Sunday, March 27, 2005

For the average homeowner, the most tragic word in the mortgage vocabulary is foreclosure.

The single biggest asset they'll ever own is their house. But because studies show that 24 percent of Americans are functionally illiterate or financially unsophisticated, they fall easy prey to shady lenders and wind up losing their house. Foreclosures have increased 200 percent since 1980, and in one recent year topped 600,000. And as property values increase, the lender recovers its losses -- and then some -- through the sale of the house.

A main target is elderly citizens, 80 percent of whom own their house outright but are strapped for cash and need money for medical bills, home improvements and other reasons. The scams are so outrageous that many folks eventually lose the equity they've built up.

The culprits are:

1) Predatory mortgage lenders, who make high-cost loans based on the assets of the borrower without regard to his or her ability to pay them back, which more often than not ends up in foreclosure. In addition, predatory loans may contain rip-off credit, life-insurance or transactional fees. Other examples: balloon payments, which smack the homeowner with one towering payment after several years; and "flipping," which means refinancing several times to get more cash, with higher rates and more fees each time.

One 69-year-old woman, earning $600 a month, got a $15,000 home-improvement loan. Over the next year, she was conned into flipping her original loan into several new loans. Fifteen months later, she found herself owing $98,000 and now faces foreclosure threats.

2) Sub-prime loans, extending credit at higher-than-average interest rates to borrowers with risky credit records. Such lending is common, but in the hands of shady operators, the loans can be devastating.

A new trick has now cropped up, thanks to an increase in house values in many markets. Mortgage sources confide that some unscrupulous lenders are purposely allowing certain borrowers to fall deeper into a financial hole from which they can't escape. Why? Because it pushes these consumers into foreclosure, whereupon the lender grabs the house and sells it at a profit.

The scenario might go like this:

Joe and Mary Smith's regular mortgage payument is $1,570. But they're five months in arrears, for a total of $7,850. They also get hit with $2,300 in fees for an attorney hired by the bank, plus $440 in late fees and $125 for additional appraisal fees. That comes to $10,715.

Under a payoff plan, the bank demands half up front -- $5,357.50 -- and the rest over six months. Previously, it might have allowed them 12 months to catch up. Added to their regular payment, that brings the Smiths' monthly tab to $2,463, but with their heatlh and job problems, they can't handle it. Bingo! The bank forecloses on the hapless family and makes out like a bandit because the house's value has appreciated 21 percent in the past couple of years.

I'm not saying all lenders play this game -- hardly. But it does happen. A mortgage specialist who spoke on condition of anonymity said he'd seen lenders let borrowers get as many as 9 or 10 months behind before they crack down. Similarly, they allow cash-poor buyers to finance a house with as little as 5 percent down, and incur bigger monthly payments. Result: a more likely foreclosure.

Obviously these scary situations are the exception rather than the rule.

But be cautious. Don't use your house as collateral unless you're sure you can repay the loan -- and that goes for "debt consolidation" loans, too. Slow down; don't act quickly. Shop for the best loan terms and interest. Ask questions and get explanations for anything you don't understand. Have legal or financial counsel review everything before you sign. (Remember, you can always change your mind,) And try to make your mortgage payments on time.

Check out AARP's Web site at AARP.org/home loans, and file any complaints with the Federal Trade Commission by calling (877) 382-4357.

Bottom line: Be careful. It's a jungle out there!

Robert K. Heady is co-author of Complete Idiot's Guide to Managing Your Money. He invites reader mail on consumer money problems and solutions but cannot respond personally. Send e-mail to jrnl8888 [at] aol.com, or write to P.O. Box 14875, North Palm Beach, FL 33408.