Interest-only loans, interest-only adjustable rate loans, short-term adjustable rate loans, optional payment and payment options loans, and negative amortizing loans... the list is long and nearly every one of these mortgage programs has as many negative risks to them as they may have positive and beneficial aspects.
The federal regulators, Wall Street mortgage securities firms and mortgage bankers know this as well. Each entity has recently issued guidance concerns to address the risks posed by these residential mortgage products that allow borrowers to delay, defer and, with some of these programs, not even pay the amount of interest that may be due in any given month. More often than not, the primary similarity in each loan program is that the terms will allow the borrower to pay a lower monthly payment at the onset of the mortgage for a specific period of time in exchange for higher payments and/or rates later in the term of the loan.
Many of these types of programs have been available to the consumer for quite a while. What has changed over the past few years, though, is that the number of lenders offering these programs and the number of consumers choosing them has significantly increased—some experts estimate by as much as 300 to 500%. In previous years, the more financially sophisticated, higher-income professionals or self-employed business owners were targeted for these programs. The real risk and concern is that it has become the median-income, standard W-2, typical middle-America borrower that has been "sold" these programs more than ever before. These, for the most part, are borrowers that can least afford to take on the risks.
The greatest risks lie in a couple of arenas: first, real estate values are presumed to be flat and even declining in many areas of the country. It has been the gamble of many of the borrowers that they would see continued escalating values and growing equity that would offset any possible negative implications or costs to these programs they might encounter in the future, and borrowers could simply refinance or sell before those potential risks might come back to haunt them. The press has made us well aware of the changing markets and just how much of a gamble this has truly become.
Secondly, many borrowers just assume their income will grow over time and this sense of personal optimism would offset the inherent risks. What happens then if their income grows at an atypical historic rate of 1 to 2% and the negative costs to the loan program coupled with possible rising interest rates and flat values or even declining values is even slightly worse than a borrower expected?
But that is not where the risks end! Now factor in the bludgeoning rate of second and equity mortgages (many, too, with adjustable rates tied to a much more volatile prime rate index) that the borrowers have added on to their homes as a means of trying to pay off their ever-climbing consumer debt. The risks in all these mortgages just climbed even more.
The results have yet to be felt by either the consumer, Wall Street, or the mortgage industry. The fear is a rise in foreclosures and bankruptcies. In 2007 and 2008, it is anticipated that over $1 trillion in adjustable-rate, interest-only, and optional- payment loan programs will be coming up for their rate adjustments and the consumers will be forced to refinance, sell, or just try as best they can to make house payments that could very well go up to between 30% and 50% over what they were paying when they initially closed their mortgage.
So the real question?
Is the mortgage industry itself at least partially to blame for the possibility of the real estate bubble bursting in the near future? Armed with loan programs disguised as creative alternatives to help the consumer and the housing industry, one could easily accuse the mortgage industry as a whole of not only designing programs specifically to fill their own coffers with future refinances, but also of forcing unsuspecting consumers into taking on financial risks and even ruin by recommending these high-risk loans.
The mortgage industry and their predatory pursuit of more and more business and profits has blinded them to their responsibilities, and in that, are the lenders liable at all for what may be coming around the corner? Time will tell.
For real estate investors and well-informed borrowers, this may also prove to have some upside in some markets. Foreclosures were up over 43% in the end of 2006 already and expected to continue to climb even higher in 2007 and 2008. Watch for some real deals out there, but be careful... there are quite a few in which the borrower, the lender, and the home is upside down in equity. Good luck!
Ron Cahalan can be contacted at roncahalan@mac.com. His press kit can be found at roncahalan.presskit247.com.
