Mortgage Discussion - Concerns Mount About Mortgage Risks

Author

Concerns Mount About Mortgage Risks

Grover C. McCoury III

2005-06-17, 11:27 pm

By RUTH SIMON
The Wall Street Journal

5/18/05
In the latest sign of how frothy the housing market has become, new data
show the degree to which people are stretching to buy homes in a hot housing
market.

The data, from the Mortgage Bankers Association, show that adjustable-rate
and interest-only mortgages accounted for nearly two-thirds of mortgage
originations in the second half of last year. Both types of loans have
helped fuel the strong housing market since they carry lower initial monthly
payments than do fixed-rate loans, enabling borrowers to purchase
more-expensive homes.

With such loans accounting for an increasing portion of consumer borrowing,
some mortgage analysts worry that the growth of these loans could cause
problems for the housing market and broader economy. "The situation with
interest-only ARMs is just one of several very scary things going on in the
mortgage industry," says Stu Feldstein, president of SMR Research Corp., a
market-research firm in Hackettstown, N.J. The rise of interest-only loans,
combined with other factors such as higher debt levels and changing
bankruptcy laws, are likely to cause foreclosures to rise, he says,
"possibly dramatically."

Though it has been clear that borrowers in high-priced markets have been
gravitating to products that make homes more affordable, the shift has been
greater than expected. In California, where home-price growth has been
sizzling, interest-only loans accounted for 61% of the mortgages taken out
to buy homes in the first two months of this year, up from 47.1% in 2004 and
less than 2% in 2002, according to an analysis prepared for The Wall Street
Journal by San Francisco researchers LoanPerformance, a unit of First
American Corp. Just 18% of California households can afford to buy a
median-price house using a conventional 30-year fixed-rate mortgage,
according to a report issued this month by the California Association of
Realtors.

In another report issued this month, mortgage strategists at UBS AG called
the shift to ARMs and nontraditional mortgage products such as interest-only
loans "symptomatic of...the end of the housing cycle. The thing that all of
these loans have in common is that they allow homeowners to buy a more
expensive home than they could have qualified for with a 'traditional'
loan."

The Mortgage Bankers Association conducted the survey of the interest-only
and ARM share of mortgage originations in an effort to provide more accurate
information about the housing market. The group's survey found that
interest-only mortgages accounted for 17% of loans originated in the second
half of 2004. And 46% of loans were adjustable-rate loans that don't carry
an interest-only feature. The data reflect dollars lent, not the number of
mortgages.

This is the first time the group has measured the share of interest-only
loans, in which borrowers lower their monthly outlay by paying interest and
no principal in the loan's early years. It also is the first time it has
looked at loans actually granted, not merely applications.

The findings are the latest evidence that borrowers have moved decisively
away from traditional 30-year fixed-rate mortgages and have embraced ARMs
and, in particular, interest-only loans, which used to be a niche product.
Though borrowers take out these loans for many reasons, the shifts come at a
time when both home prices and competition among mortgage lenders has
climbed. The MBA's weekly surveys -- which look only at application volume,
not loans that are actually made -- had put the share of ARMs, including
interest-only loans, at roughly 40% to 50% this year. That is up from as
little as 18% of application volume in early 2003.

The surge in ARMs and interest-only loans is particularly notable because
rates on 30-year fixed-rate mortgages remain below 6%, still low by
historical standards. Borrowers typically turn to ARMs as interest rates
climb, but so far the increase in rates has been modest. Many economists see
the current popularity of ARMs and interest-only loans as the latest sign of
how borrowers are stretching to buy homes they couldn't otherwise afford --
and of how lenders are more than willing to accommodate them.

Partly because of these products, mortgage originations are expected to
total nearly $2.5 trillion this year, according to the MBA, down slightly
from $2.6 trillion in 2004.

Products such as interest-only mortgages can be riskier than fixed-rate
mortgages, particularly when interest rates are rising. If home prices fall
as rates rise, some borrowers with interest-only loans could wind up owing
more than the value of their home. Even if the growth in home prices simply
flattens or slows, some borrowers could be squeezed by rising mortgage
payments.

In another sign that worries about lending practices are increasing, federal
banking regulators yesterday issued new guidance for lenders making
home-equity loans and lines of credit. The guidelines require banks to do a
more in-depth analysis of borrowers' income and debt levels and their
ability to repay the loan -- instead of relying simply on credit scores.

Initially aimed at sophisticated borrowers who wanted to free up cash for
other purposes, such as investing in the stock market, interest-only loans
have come to dominate some segments of the mortgage market. A report issued
in January by UBS found that the interest-only share of jumbo loans --
currently, loans exceeding $359,650 -- had tripled since the end of 2003.

Michael Menatian, a mortgage banker in West Hartford, Conn., says he is
seeing some borrowers opt for interest-only loans over mortgages that carry
a lower interest rate but result in a higher monthly payment.

If home prices continue to surge, affordability could this year reach its
worst-ever levels in hot markets such as Los Angeles, Boston and Miami,
according to recent report by Goldman Sachs Group Inc. senior economist Jan
Hatzius.

The MBA survey highlights other changes in the mortgage market that may
increase risks to borrowers and lenders. More than half of the
adjustable-rate loans were "traditional" ARMs, meaning the initial interest
rate is fixed for less than three years. Borrowers who opt for these loans
typically get a lower initial interest rate in exchange for giving up
protection from future rate increases.

Until recently, so-called hybrid ARMs had been a more popular choice. These
loans typically carry a higher initial interest rate, but are considered a
more-conservative option because the interest rate is fixed for the first
three, five, seven or 10 years. That makes it more likely that the borrowers
will move or see their incomes increase before they face higher payments.

The shift to short-term ARMs has occurred even as the difference between
rates on ARMs and fixed-rate loans has narrowed, reducing the attractiveness
of adjustables. "To have a lower initial monthly payment, people have gone
for shorter-term ARMs," says Fannie Mae Chief Economist David Berson.

As the use of more novel lending programs becomes commonplace, some mortgage
analysts worry that borrowers are adding to the risks by combining a number
of features -- using, for instance, 100% financing and an interest-only
mortgage or a no- or low-documentation loan to buy a property for
investment. "These things layer on each other," says Mark Milner, senior
vice president and chief risk officer of PMI Mortgage Insurance Co., a unit
of PMI Group Inc. During the past year, PMI has increased its charges for
insuring riskier loans, Mr. Milner says.

Jeff Strickland

2005-06-17, 11:27 pm

The mortgage lenders have also studied how long most people keep a mortgage,
and they found that the vast majority of home mortgages are rewritten after
about 7 years. If this is true, then why would anybody take a 30-year
mortgage when if they are going to refi anyway, they can take a 5-year
mortgage and get a substatnially lower interest rate.

Borrowers only NEED for the market to remain flat to avoid problems down the
road.

"Grover C. McCoury III" <gcmccoury@yahoo.com> wrote in message
news:V8Gdnc76FoxbxgHfRVn-hA@adelphia.com...

quote:

> By RUTH SIMON
> The Wall Street Journal
>
> 5/18/05
> In the latest sign of how frothy the housing market has become, new data
> show the degree to which people are stretching to buy homes in a hot
> housing market.
>
> The data, from the Mortgage Bankers Association, show that adjustable-rate
> and interest-only mortgages accounted for nearly two-thirds of mortgage
> originations in the second half of last year. Both types of loans have
> helped fuel the strong housing market since they carry lower initial
> monthly payments than do fixed-rate loans, enabling borrowers to purchase
> more-expensive homes.
>
> With such loans accounting for an increasing portion of consumer
> borrowing, some mortgage analysts worry that the growth of these loans
> could cause problems for the housing market and broader economy. "The
> situation with interest-only ARMs is just one of several very scary things
> going on in the mortgage industry," says Stu Feldstein, president of SMR
> Research Corp., a market-research firm in Hackettstown, N.J. The rise of
> interest-only loans, combined with other factors such as higher debt
> levels and changing bankruptcy laws, are likely to cause foreclosures to
> rise, he says, "possibly dramatically."
>
> Though it has been clear that borrowers in high-priced markets have been
> gravitating to products that make homes more affordable, the shift has
> been greater than expected. In California, where home-price growth has
> been sizzling, interest-only loans accounted for 61% of the mortgages
> taken out to buy homes in the first two months of this year, up from 47.1%
> in 2004 and less than 2% in 2002, according to an analysis prepared for
> The Wall Street Journal by San Francisco researchers LoanPerformance, a
> unit of First American Corp. Just 18% of California households can afford
> to buy a median-price house using a conventional 30-year fixed-rate
> mortgage, according to a report issued this month by the California
> Association of Realtors.
>
> In another report issued this month, mortgage strategists at UBS AG called
> the shift to ARMs and nontraditional mortgage products such as
> interest-only loans "symptomatic of...the end of the housing cycle. The
> thing that all of these loans have in common is that they allow homeowners
> to buy a more expensive home than they could have qualified for with a
> 'traditional' loan."
>
> The Mortgage Bankers Association conducted the survey of the interest-only
> and ARM share of mortgage originations in an effort to provide more
> accurate information about the housing market. The group's survey found
> that interest-only mortgages accounted for 17% of loans originated in the
> second half of 2004. And 46% of loans were adjustable-rate loans that
> don't carry an interest-only feature. The data reflect dollars lent, not
> the number of mortgages.
>
> This is the first time the group has measured the share of interest-only
> loans, in which borrowers lower their monthly outlay by paying interest
> and no principal in the loan's early years. It also is the first time it
> has looked at loans actually granted, not merely applications.
>
> The findings are the latest evidence that borrowers have moved decisively
> away from traditional 30-year fixed-rate mortgages and have embraced ARMs
> and, in particular, interest-only loans, which used to be a niche product.
> Though borrowers take out these loans for many reasons, the shifts come at
> a time when both home prices and competition among mortgage lenders has
> climbed. The MBA's weekly surveys -- which look only at application
> volume, not loans that are actually made -- had put the share of ARMs,
> including interest-only loans, at roughly 40% to 50% this year. That is up
> from as little as 18% of application volume in early 2003.
>
> The surge in ARMs and interest-only loans is particularly notable because
> rates on 30-year fixed-rate mortgages remain below 6%, still low by
> historical standards. Borrowers typically turn to ARMs as interest rates
> climb, but so far the increase in rates has been modest. Many economists
> see the current popularity of ARMs and interest-only loans as the latest
> sign of how borrowers are stretching to buy homes they couldn't otherwise
> afford -- and of how lenders are more than willing to accommodate them.
>
> Partly because of these products, mortgage originations are expected to
> total nearly $2.5 trillion this year, according to the MBA, down slightly
> from $2.6 trillion in 2004.
>
> Products such as interest-only mortgages can be riskier than fixed-rate
> mortgages, particularly when interest rates are rising. If home prices
> fall as rates rise, some borrowers with interest-only loans could wind up
> owing more than the value of their home. Even if the growth in home prices
> simply flattens or slows, some borrowers could be squeezed by rising
> mortgage payments.
>
> In another sign that worries about lending practices are increasing,
> federal banking regulators yesterday issued new guidance for lenders
> making home-equity loans and lines of credit. The guidelines require banks
> to do a more in-depth analysis of borrowers' income and debt levels and
> their ability to repay the loan -- instead of relying simply on credit
> scores.
>
> Initially aimed at sophisticated borrowers who wanted to free up cash for
> other purposes, such as investing in the stock market, interest-only loans
> have come to dominate some segments of the mortgage market. A report
> issued in January by UBS found that the interest-only share of jumbo
> loans -- currently, loans exceeding $359,650 -- had tripled since the end
> of 2003.
>
> Michael Menatian, a mortgage banker in West Hartford, Conn., says he is
> seeing some borrowers opt for interest-only loans over mortgages that
> carry a lower interest rate but result in a higher monthly payment.
>
> If home prices continue to surge, affordability could this year reach its
> worst-ever levels in hot markets such as Los Angeles, Boston and Miami,
> according to recent report by Goldman Sachs Group Inc. senior economist
> Jan Hatzius.
>
> The MBA survey highlights other changes in the mortgage market that may
> increase risks to borrowers and lenders. More than half of the
> adjustable-rate loans were "traditional" ARMs, meaning the initial
> interest rate is fixed for less than three years. Borrowers who opt for
> these loans typically get a lower initial interest rate in exchange for
> giving up protection from future rate increases.
>
> Until recently, so-called hybrid ARMs had been a more popular choice.
> These loans typically carry a higher initial interest rate, but are
> considered a more-conservative option because the interest rate is fixed
> for the first three, five, seven or 10 years. That makes it more likely
> that the borrowers will move or see their incomes increase before they
> face higher payments.
>
> The shift to short-term ARMs has occurred even as the difference between
> rates on ARMs and fixed-rate loans has narrowed, reducing the
> attractiveness of adjustables. "To have a lower initial monthly payment,
> people have gone for shorter-term ARMs," says Fannie Mae Chief Economist
> David Berson.
>
> As the use of more novel lending programs becomes commonplace, some
> mortgage analysts worry that borrowers are adding to the risks by
> combining a number of features -- using, for instance, 100% financing and
> an interest-only mortgage or a no- or low-documentation loan to buy a
> property for investment. "These things layer on each other," says Mark
> Milner, senior vice president and chief risk officer of PMI Mortgage
> Insurance Co., a unit of PMI Group Inc. During the past year, PMI has
> increased its charges for insuring riskier loans, Mr. Milner says.
>
>

Steve Horrillo

2005-06-17, 11:27 pm

On 3-Jun-2005, "Jeff Strickland" <crwlr@yahoo.com> wrote:

quote:

> The mortgage lenders have also studied how long most people keep a
> mortgage,
> and they found that the vast majority of home mortgages are rewritten
> after
> about 7 years. If this is true, then why would anybody take a 30-year
> mortgage when if they are going to refi anyway, they can take a 5-year
> mortgage and get a substatnially lower interest rate.

Because the monthly payment is lower on a 30 year mortgage than on a 5 year
one? I'm coming in mid conversation so am I missing something here?

--
Warmest regards,

Steve Horrillo, Realtor | Trainer | Hypnotherapist
http://brokeragenttraining.com (Advanced training for real estate
professionals)
http://over100percent.com (Realtors earn over 100 percent)

Jeff Strickland

2005-06-17, 11:27 pm

"Steve Horrillo" <usenet@stephenhorrillo.com> wrote in message
news:gm6oe.46239$8S5.33841@bignews3.bellsouth.net...

quote:

>
> On 3-Jun-2005, "Jeff Strickland" <crwlr@yahoo.com> wrote:
>
>
> Because the monthly payment is lower on a 30 year mortgage than on a 5
> year
> one? I'm coming in mid conversation so am I missing something here?
>

Not true. A 5 year mortgage is not a mortgage that is paid in full after 5
years, it is a 30 year mortgage that is a fixed rate for the first 5 years,
then goes to an adjustable. The borrower takes on a degree of uncertainty
that the investors reward by giving a lower rate. If the borrower takes a
30, then the investors are tied to the interest rate for 30 years, but if
the borrower takes a 5, then the investors are out of any negative exposure
after 5 years and they reward the borrower with a lower rate because he
takes on much of the risk that the investors would normally take.

If I take a new 30 today, it will be at 5.5%, but I can take a 5/1 ARM for
4.75% and save three quarters of a point on my payment for the next five
years. This can amount to thousands of dollars in lower payments. But, I am
exposed to the risk that interest rates in 5 years will be higher than they
are today, and when I refinance after that time, I am uncertain what will
happen to my payment. I can hope that I have significant equity appreciation
and can take a lower LTV loan that I have now, and I can hope that I am
making more money and can afford a higher payment, or I can plan today on
selling the house and getting out of the mortgage altogether.

No matter what the case in 5 years, if I go into the transaction today with
the knowledge that in 5 years I am going to refinance or sell, then why
should I take a higher rate on a 30-year mortgage than I can get on a
mortgage that is closer to the term that I expect to keep the loan anyway?
If I can get a 4.75 loan today instead of a 5.50, then shouldn't I take the
lower rate?

If I was planning on keeping the loan I get today until it is paid off, then
I would absolutely want to get the most security I could find, and in this
case I'd take the 30, or I'd arguably be foolish to take anything else. But
if I knew that in 5 years I'd be refinancing at the then-current rate, then
I could save thousands of dollars by taking a shorter-term loan.

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