Do You Know Your Loan?
Saturday, June 3, 2006
Pat Smucker knows exactly how much she owes on her house, what the loan terms are, how the interest rate has doubled in the past four years and that the rate could go even higher before her retirement home in Florida is finished.
But then, the Sterling resident has a big advantage over most borrowers: She worked in banking for 33 years before retiring recently. So she's well aware of myriad loan types and terms and the relative risks of new loan products.
Smucker and her husband, Joe, a retired federal government worker, were among the most clued-in home borrowers interviewed at random recently at Reston Town Center. Though their mortgage was the furthest thing from their minds as they cooled down from a bike ride to the mall, the couple agreed to participate in an informal survey of what borrowers know about their mortgage loans.
The sidewalk survey was just a simple quiz. What do you know, and when did you know it? Eight out of 11 mortgage holders knew quite a lot -- a decent percentage, wouldn't you say?
But consumer activists, regulators and industry groups are taking heed of more comprehensive studies that suggest that a growing group of borrowers -- those with adjustable-rate mortgages, or ARMs -- might not understand what they have signed up for. With estimates that perhaps a third or more of borrowers are taking out more risky ARM loans now, compared with less than 7 percent four years ago, the question of what people understand about their loans and whether they will be able to afford them if rates rise has taken on even more importance, according to the experts.
Federal Reserve Board Chairman Ben S. Bernanke and other regulators, for example, have warned that exotic mortgages issued in recent years to less creditworthy home buyers could pose problems if the housing market cools dramatically. And Bernanke testified last week on Capitol Hill about how consumers need more financial knowledge in general to "navigate today's increasingly complex financial services marketplace."
Or, as your mother always told you, what you don't know can hurt you.
Ever-more-exotic types of loans originally marketed mostly to the affluent have become commonplace as borrowers have strived to keep up with ever-increasing house prices. As with traditional ARMs, rates on these loans start out lower than fixed rates but adjust with the market. The newer ARMs may offer borrowers the option to pay only the interest on the loan, or to choose how much principal or interest to pay. The attraction is lower monthly payments. But as these interest-only and "option" loans have become more available, the notion that payments will ratchet up one day and the understanding of how they adjust may be getting lost, experts warn.
"If borrowers do not know their mortgage terms, they may be surprised by the changes in their payments if interest rates rise and thus may subsequently experience financial difficulties," warn the authors of one recent study on borrower awareness done by two Fed economists.
"People just don't understand these new mortgage products," Allen Fishbein, director of credit and housing policy for the Consumer Federation of America, said last week. "And the stakes are much higher now because the terms permit substantial adjustments upward in their mortgage payments." The federation a year ago published a study saying that borrowers, particularly minorities and low-income consumers, were getting inappropriate loans or choosing them for the wrong reasons.
The Reston lunch-bunch survey didn't turn up anyone who was panicked about his loan -- after all, interest rates are still relatively low in comparison with past decades -- but the results were similar to those of the more academic studies.
The Fed economists' report, published this spring, concluded that about 35 percent of borrowers with ARMs didn't know how much their interest rate could jump, or reset, at any one time. And 41 percent of those holding ARMs weren't sure of the maximum interest rate they might have to pay.