Friday, September 01, 2006

The Mortgage Time Bomb is Ticking

The Mortgage Time Bomb Is Ticking

“Option ARMs were created in 1981 and for years were marketed to well-heeled home buyers who wanted the option of making low payments most months and then paying off a big chunk all at once. For them, option ARMs offered flexibility. So how did these unusual loans get into the hands of so many ordinary folks? The sequence of events was orderly and even rational, at least within a flawed system. In the early years of the housing boom, falling interest rates made safe fixed-rate loans attractive to borrowers. As home prices soared, banks pushed adjustable-rate loans with lower initial payments. When those got too pricey, banks hawked loans that required only interest payments for the first few years. And then they flogged option ARMs -- not as financial-planning tools for the wealthy but as affordability tools for the masses. Banks tapped an army of unregulated mortgage brokers to do what needed to be done to keep the money flowing, even if it meant putting dangerous loans in the hands of people who couldn't handle or didn't understand the risk. And Wall Street greased the skids by taking on much of the new risk banks were creating. Now the signs of excess are crystal clear. Up to 80% of all option ARM borrowers make only the minimum payment each month, according to Fitch Ratings. The rest of the money gets added to the balance of the mortgage, a situation known as negative amortization. And once balances grow to a certain amount, the loans automatically reset at far higher payments. Most of these borrowers aren't paying down their loans; they're underpaying them up.”

Joe and Jane Sixpack are in for a rude awakening in the next few months. Their exuberance to live the AmeriKKKan Dream may soon morph into a financial nightmare. The recent housing and refinancing boom was fueled by unusually low interest rates set by the US Central Bank and exotic mortgages that enable many people who would not normally qualify for a home loan to acquire one with little or no money down and lower payments. The problem for many of those who took advantage of these exotic mortgages or the adjustable rate mortgages (mortgages whose interest and repayment rates fluctuated according to the prevailing interests set by the Federal Reserve Central Banks) is they are now experiencing personal/household budget payment shock as interest rates climb and the terms of their mortgage payments catch up to them during an inflationary period where their salaries have either remained stagnant or lost ground. In the most recent issue of Business Week Magazine’s online version there is a very revealing piece on what they call “Nightmare Mortgages”. “The option adjustable rate mortgage (ARM) might be the riskiest and most complicated home loan product ever created. With its temptingly low minimum payments, the option ARM brought a whole new group of buyers into the housing market, extending the boom longer than it could have otherwise lasted, especially in the hottest markets. Suddenly, almost anyone could afford a home -- or so they thought. The option ARM's low payments are only temporary. And the less a borrower chooses to pay now, the more is tacked onto the balance. The bill is coming due. Many of the option ARMs taken out in 2004 and 2005 are resetting at much higher payment schedules -- often to the astonishment of people who thought the low installments were fixed for at least five years. And because home prices have leveled off, borrowers can't count on rising equity to bail them out. What's more, steep penalties prevent them from refinancing. The most diligent home buyers asked enough questions to know that option ARMs can be fraught with risk. But others, caught up in real estate mania, ignored or failed to appreciate the risk.”
What does this mean for Joe ad Jane Sixpack? It means they will no longer be able to use their home as an ATM card and draw money out based on the equity they had accumulated in their homes or secure loans based upon the increased value of their home the housing boom spurred. The housing boom is over, interest rates have increased and the fine print in the exotic loans are about to catch the unsuspecting borrowers off guard at a most inappropriate time when the cost of living is rising and wages are stagnant. It means they will look up one month and find their mortgage payment has skyrocketed and their options are extremely limited. In effect they were set up by the banking industry and their mortgage broker. “There was plenty more going on behind the scenes they didn't know about, either: that their broker was paid more to sell option ARMs than other mortgages; that their lender is allowed to claim the full monthly payment as revenue on its books even when borrowers choose to pay much less; that the loan's interest rates and up-front fees might not have been set by their bank but rather by a hedge fund; and that they'll soon be confronted with the choice of coughing up higher payments or coughing up their home. The option ARM is ‘like the neutron bomb,’ says George McCarthy, a housing economist at New York's Ford Foundation. ‘It's going to kill all the people but leave the houses standing.’”
We are already seeing a rise in home foreclosures where people can not longer afford the houses or the mortgage payments. The average Joe is also feeling the pinch of rising interest rates, inflation (an increase in the money supply which makes all things more expensive) and stagnant wages. In the Wall Street Journal’s online guide to property, there is an article that examines the current reliance on exotic mortgages but it also looks at their downside. “While traditional long-term, fixed-rate mortgages remain the loan of choice for the majority of home buyers, more borrowers are also shopping for interest-only loans, pay-option ARMs and hybrid fixed-ARM loans. That's particularly true in high-cost housing markets, where taking one of those loans may be the only way to afford a house. It worked well when double-digit home-price gains built equity while leaving more cash in homeowners' pockets. Low interest rates muted the potential sting of upward rate adjustments. But neither of those conditions exist today: Interest rates are well above year-ago levels and home-price gains have cooled or, in some of the hottest markets, already started to erode. One big problem, says Callanan, is that household incomes haven't been rising as fast as interest rates, creating greater affordability hurdles for home buyers. Borrowers who use these loans now are challenged more than ever to gauge the health of home prices in their area and measure their ability to stay on top of payments, and to know when to refinance.”
Unfortunately many first time home buyers caught up in the exhilaration of home ownership or wild eyed folks trying to “keep up with the Joneses” aren’t that knowledgeable or sophisticated. Most don’t understand the inner workings of the lending industry and are easy prey for the hype of sophisticated versions of predatory lending. "To get the deals done, banks have turned increasingly to unregulated mortgage brokers, who now account for 80% of all mortgage originations, double what it was 10 years ago, according to the National Association of Mortgage Brokers. In 2004 banks began offering fatter sales commissions on option ARMs to encourage brokers to push them, says Gail McKenzie, assistant U.S. attorney in Atlanta, who is investigating mortgage brokers for improper practices. The problem, of course, is that many brokers care more about commissions than customers. They use aggressive sales tactics, harping on the minimum payment on an option ARM and neglecting to mention the future implications. Some even imply verbally that temporary teaser rates of 1% to 2% are permanent, even though the fine print says otherwise. It's easy to confuse borrowers with option ARM numbers. A recent Federal Reserve study showed that one in four homeowners is mystified by basic adjustable-rate loans. Add multiple payment options into the mix, and the mortgage game can be utterly baffling... Most of the pain will be born by ordinary people. And it's already happening. More than a fifth of option ARM loans in 2004 and 2005 are upside down -- meaning borrowers' homes are worth less than their debt. If home prices fall 10%, that number would double. ‘The number of houses for sale is tripling in some markets, so people are not going to get out of their debt," says the Ford Foundation's McCarthy. ‘A lot are going to walk.’” The number of houses for sale is tripling in some markets, so people are not going to get out of their debt," says the Ford Foundation's McCarthy. "A lot are going to walk."
Real estate agents and mortgage lenders attempted to accommodate people’s desire to purchase a home and many were sold mortgage products that may have seemed affordable at that time using exotic mortgages but now a few years later are beyond their means for a myriad of reasons. Most folks are feeling the pinch on their wallets anyway due to rising energy costs and inflation, but many now find themselves sitting on a ticking time bomb that has the potential to devastate their world.


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