For years, the word “variety” wasn’t part of a mortgage lender’s vocabulary.
The options available to customers consisted largely of 15-year and 30-year loans with fixed interest rates and a few with adjustable rates.
But an explosive demand for housing and the abundance of money to lend changed that. Lenders in recent years have devised an array of alternatives for home buyers, including:
– Adjustable-rate mortgages with low introductory rates that last as long as 10 years.
– Mortgages, dubbed option ARMs, that allow borrowers to vary the size of their monthly payment.
– Mortgages that require only interest payments and postpone the payments on principal.
Prospective borrowers who have compared some of the available mortgages have called to ask, “What’s on the menu today?” said Bill West Sr., a loan officer with Enterprise Mortgage Corp. in Virginia Beach, Va.
Lenders’ innovations have enabled many borrowers to buy a larger home than would have been possible in the past.
More-flexible loans also have helped buyers who once would have been shut out.
Bank regulators and credit-rating agencies, however, have reacted to the promotion of some less traditional mortgage loans with warning flares. They’ve expressed concern about lenders’ relaxed credit standards and the heightened risk of the innovative loans.
More warnings from regulators are likely, said Keith T. Gumbinger, a veteran mortgage analyst and vice president of the financial publishing firm HSH Associates in Pompton Plains, N.J.
By historic measures, mortgage delinquencies and home foreclosures are modest. The demand for homes remains robust, and mortgage credit is readily available.
That, however, may not be the case when the low introductory rates on many non-traditional mortgages are readjusted in a few years, and the size of borrowers’ monthly payments suddenly jumps.
“You could find borrowers set up for a difficult time down the road,” Gumbinger said.
The combination of innovative lending and looser credit standards, he said, has yet to be tested by a difficult economic environment.
In May, a coalition of federal regulators, including the Federal Reserve Board of Governors, Comptroller of the Currency and Federal Deposit Insurance Corp., cautioned financial institutions to look more closely at their applicants’ financial resources when making home equity lines of credit.
Among the conditions that provoked their attention, regulators told banks, were interest-only features that required no amortization of principal for a prolonged period and limited documentation of borrowers’ assets, employment and income.
With assistance from lenders, some borrowers have used “piggyback” combinations of interest-only home equity loans with long-term, fixed-rate loans to finance the purchase of a home.
In addition, some homeowners have tapped home equity lines of credit to buy second and third homes for investment or quick resale.
In another warning, the rating agency Standard & Poor’s said late last month that it will impose more rigorous standards when measuring the creditworthiness of certain adjustable-rate mortgages that lenders package and sell to investors.
These loans, dubbed option ARMs, allow borrowers to choose the amount of their monthly payment and offer the option of paying only a portion of the interest due each month while postponing payment of any of the principal.
One reason for the regulators’ mounting concern is the reliance that lenders have placed on a mortgage applicant’s credit score.
The computer-generated numbers, calculated by weighing such factors as the individual’s repayment history and amount of outstanding debt, have become essential for making auto loans and determining borrowing limits on credit cards.
Mortgage lenders once relied on a handful of financial ratios to decide whether an applicant was qualified for a loan and how much they could borrow.
An income ratio, for instance, required that the borrower’s monthly housing expenses, including homeowners insurance premiums and property taxes, not exceed 28 percent of their monthly income.
Another ratio required that the borrower’s total debt, including payments for housing expenses and payments for car loans and credit cards, not exceed 36 percent of their monthly income.
With the emphasis on an applicant’s credit score, “the old ratios aren’t there, particularly for home buyers who have good credit,” said West of Enterprise Mortgage.
Adjustable-rate mortgages have gained broader acceptance, especially among home buyers who expect to be moving in a few years.
Instead of using a 30-year, fixed-rate mortgage, these borrowers often stand to benefit by paying the lower interest rate on an adjustable-rate loan before it readjusts, said Pat Hillard, manager of the Wells Fargo Home Mortgage office in Virginia Beach.
“People don’t live in the same home for 30 years,” Hillard said. “I don’t know of a single home buyer who says, `This is going to be our house forever.'”
Worries that home buyers using interest-only loans and other innovative mortgages will be hit by onerous monthly payments have been overdone, Hillard said.
“Most people I’m dealing with have made good decisions” in their choices of loans, Hillard added.
When she and her husband were shopping for a home last year, Melissa Kessell compared the details of several types of mortgages, including long-term, fixed-rate loans and those with adjustable rates and interest-only features.
After renting a home in Suffolk for 2 1/2 years, she and her husband were stunned by the continued rise in home prices, she said.
Rather than resorting to a more flexible, adjustable-rate mortgage loan that would have provided a lower monthly payment to start, they chose a long-term, fixed-rate loan when they found a home in March.
“I don’t like to take financial risks,” said Kessell, an accountant in the Norfolk, Va., office of Advantis Real Estate. “I was pretty sure that a 30-year, fixed-rate loan was what we needed.”
Still, it wouldn’t require a collapse in prices to cripple some homeowners.
Many who have financed their purchases with interest-only loans have assumed that their homes will appreciate as housing prices continue climbing.
If short-term rates keep rising and home prices don’t, some of these borrowers could end up owing more on their mortgages than their homes are worth.
That would be painful for homeowners who are forced to sell their homes but lack the cash to make up the difference between sales price and mortgage amount.
