Market Driving Risky Mortgages
Friday, June 3, 2005
Phil Dondes followed the experts' advice when he went looking for a mortgage for the $1.1 million home he bought last month in Burke: He consulted five lenders to compare loan rates. Four of them quickly responded with interest-only, adjustable-rate loans that would allow him to defer repaying the loan principal. They said it was the popular way to go.
"A lot of lenders are pushing, as their first offer, interest-only loans, where you don't pay down the principal," said Dondes, 46, a cemetery counselor with a stay-at-home wife and a 2-year-old daughter. He found the advice alarming because he recalls when interest rates shot up to 16 and 17 percent in the early 1980s -- and he opted for an old-fashioned 30-year, fixed-rate mortgage instead.
But Dondes is an oddity among home buyers right now. A recent survey by the Mortgage Bankers Association found that many buyers and homeowners are taking the route the lenders first recommended to Dondes. Adjustable-rate and interest-only loans together accounted for 63 percent of all loan originations in the second half of 2004, the trade group found. Meanwhile, about a fourth of buyers nationwide are taking interest-only loans, a kind of mortgage that can have fixed-rate features but is usually adjustable, according to LoanPerformance, a San Francisco-based company that tracks loan originations.
"It's higher than we've ever seen in recent years and probably ever," said Doug Duncan, chief economist of the Mortgage Bankers Association.
"We're a society that prefers instant gratification -- it's a short-term rather than a long-term focus," McElrath said.
Lenders are pushing adjustable mortgages to maintain a high sales volume at a time loan refinancings have plunged, said Christopher Cruz, a Silver Spring-based mortgage lending trainer. Loan originators, either mortgage brokers who act as middlemen between consumers and lenders, or mortgage bankers, who can also fund the loans themselves, get paid only if the transactions go through -- which gives them an incentive to make the loan payments as alluring as possible to the borrower.
It's a commission-based business. Loan originators earn fees that can range from 1 percent to about 2.5 percent of the mortgage amount, depending on whether they charge other fees and surcharges. The fees are negotiable, but many consumers don't know it, Cruz said. Mortgage brokers find interest-only and adjustable loans easier to close because the payments are lower than fixed-rate loans, and low payments help propel consumers toward purchases, he said.
"Everybody is motivated by -- and compensated by -- volume," Cruz said.
Some industry insiders tout interest-only loans as sensible financial planning tools. Tom Reed, branch manager at Wells Fargo Home Mortgage in Sterling, has bought two properties -- a vacation home and a rental -- in the past two years using interest-only loans. About 65 percent of his clients have selected interest-only loans, he said.
"The interest-only loan is giving people the extra buying power to move up and keep up with escalating values," Reed said. He said he counsels his interest-only clients to pay extra toward the principal, as he does, so they don't get caught without equity after years of payments. But he knows some people won't follow that advice.
"Some people pay the bare minimum on their credit cards every month," he said. "Some people will never get out of debt."
Indeed, many economists find it alarming that so many buyers are choosing these loans at a time fixed-rate loans remain at near-record lows. Fixed-rate mortgages are available now for about 5.25 percent for people with good credit, and adjustables are offered at about 4.75 percent -- a relatively small difference. For a $300,000 mortgage, the payment -- principal and interest only -- would be $1,657 a month on a fixed-rate loan and $1,565 for an adjustable. The big difference, however, is for a three-year interest-only adjustable: $1,219 a month because the borrower is required to pay nothing toward the principal.
Many economists think rates have nowhere to go but up, which could leave homeowners with higher payments in the future.
"I don't know anyone who thinks rates will come down," said economist Dean Baker, co-director of the District-based Center for Economic and Policy Research. "Almost everybody expects rates in three or four years to be much higher than they are today. People who are professionals are systematically misadvising people. They want to make the deal."
Economist Charles W. McMillion, president of MBG Information Services, also blames the increasing number of interest-only loans on "people clearly desperate to make loans," and he said the trend could prove financially hazardous both to borrowers and to the banks that make the loans.
"The rate at which these new financial instruments are being used should be very troubling to regulators," McMillion said.