Joining the dirgeful chorus lamenting the risky
business of easy mortgage money, Consumer Reports says
many home buyers and owners are banking home ownership
on loans that increase their odds of foreclosure.
Ever more popular because they allow home owners
repeated returns to the equity till and buyers to
purchase homes that might otherwise be unaffordable,
the home loans come with dangerous levels of risk that
could quickly become unmanageable.
Foreclosure reports recently revealed fewer defaults
and foreclosures, but Consumer Reports says that's
because the loans are relatively new. The independent
consumer advocate harps on recent government, industry
and independent warnings that reveal more and more
consumers are strung out on the loans, especially in
high-cost areas including California and Nevada where
recently more than half the loans originated are
considered the riskier variety.
The consensus of concern points to the potential for
the economy to push low interest rates higher at the
same time an unsustainable rise in foamy home prices
loses air -- a double whammy that could turn the tide
on foreclosures.
Combine the growing addiction to risky loans, higher
interest rates and falling home prices. Toss in what
the Federal Bureau of Investigation says is "organized
criminal groups and individuals engaged in significant
financial institution fraud ... including mortgage
fraud." Include the Mortgage Asset Research
Institute's (MARI) recent testimony before Congress
about spreading levels of mortgage applicant fraud.
It's getting so the bubble analogy doesn't quite hit
the mark.
Rather than the hiss of losing air or a louder pop
from sudden deflation, the housing market looks more
and more like a powder keg bristling with short fuses.
"These days, it can be easy to get a mortgage even for
a home that seems financially out of reach. And
homeowners can tap home-equity loans to finance
everything from a Lexus to a trip to Las Vegas. But
this is not such a good thing," says Consumer Reports.
"Many loans that mortgage brokers and lenders are
pushing increase the odds of foreclosure by allowing
borrowers to accept more risk than they can manage,
especially if home prices level off or if interest
rates increase," Consumer Reports reveals in "Beware
Of These Home Loans".
The Mortgage Bankers Association reports
delinquencies, defaults and foreclosures remain low
now because many of the loans are relatively new,
introduced specifically to address the escalating cost
of homes.
Also, interest rates have remained low with less than
half a percentage point separating this year's high
and low points.
Those conditions, says Consumer Reports, gives
consumers plenty of time to get out of or avoid high
risk loans.
The loans that most concern the consumer goods and
services rater are:
Interest-Only (IO) Mortgages
Interest-only loans allow borrowers each month to pay
only the interest for a period, typically 3 to 10
years. After the initial period, unless the borrower
has elected to pay down the principal, the original
principal remains intact and when it's added to the
equation (same principal-shorter term), monthly
payments can jump 25 percent, Consumer Reports warns.
Because many of the loans initially come with
artificially low adjustable rates (which allow
consumers to buy more home or a home they couldn't
otherwise afford) consumers could get smacked twice
with principal payments and a higher interest rate at
a time when it may be difficult to find a cheaper loan
as a way out or sell the property. If the home owner
hasn't paid down the principal and home prices have
slipped, the loan could flip upside down with a
balance larger than the home's value.
IOs were identified by the Federal Reserve as a
troublesome fixture in the home equity portfolios of a
growing number of lenders. The finding prompted the
reserve earlier this year to issue a warning about the
practice, "Credit Risk Management Guidance For Home
Equity Lending".
Option-Adjustable Rate Mortgages (O-ARMs)
Option ARMs leave it up to the borrower to decide on
the payment level each month. If that doesn't cover
the interest payment, the mortgage balance can grow.
An initial study by a private lender revealed that
more than half its borrowers with O-ARMs were taking
the riskiest approach and paying the bare minimum each
month.
Borrowers who opt for these option loans may find them
a great leveraging tool, especially for investment
purchases. However, use of the mortgage could also
indicate the buyer can't really afford the full
monthly payment and is gambling that will change in
the future.
If the loan balance rises to 110 to 115 percent of the
original loan, the borrower is behind the eight ball
trying to pay down the balance. An upside down
mortgage and income that can't keep up is a recipe for
financial disaster.
Piggyback Loans
Consumer Reports' August warning about risky loans
piggybacks on the PMI Group's recent study, "The
Hidden Risks Of Piggyback Lending".
Both warn that the loan is inherently risky. Piggyback
loans get their name from a second mortgage that is
"piggybacked" onto a first mortgage to compensate for
buyers unable to come up with a larger down payment or
any at all. The loan helps the buyer leverage the
transaction and avoid paying private mortgage
insurance. It also could be a red flag the borrower
wasn't financially ready to buy a home.
If the loan is adjustable, the stakes get higher in
this game of mortgage roulette. Piggybacks are also
available as home-equity lines of credit, with
interest-only features, compounding the rate of
potential risk.
In all cases borrowers are often told they can
refinance at the end of the initial low-monthly-cost
period and reduce their risk. But combine the cost of
refinancing, the potential for higher interest rates
and the possibility the home won't appraise to cover
any extra loan amounts and it's all a real crap shoot.
Consumer Reports says unless you can truly handle the
risk, don't shoot yourself in the foot. Bite the
bullet.
"With today's low interest rates, the best option for
most buyers is still a 30-year fixed loan."
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