For Mortgages, Tradition Rules Again
Saturday, March 24, 2007
Expect a back-to-basics approach to mortgages this year.
For decades, the basics boiled down to this: Your mortgage payment, including taxes and insurance, should not exceed 28 percent of your gross pay, and all your loans, mortgage included, should not exceed 36 percent.
But during the first half of this decade, when home prices shot up and interest rates hit record lows, eager borrowers did not pay much attention to the basics. Neither did lenders.
The phenomenon helped fuel the housing boom by offering all kinds of alternatives to the traditional 30-year fixed-rate mortgage. As long as home prices kept climbing, homeowners could sell or refinance if they had trouble making payments. Now that prices have leveled off, that's not an option for some.
That's why a growing number of borrowers failed to make their mortgage payments in the last quarter of 2006. A national survey by the Mortgage Bankers Association found that the number of risky, or "subprime," borrowers who missed payments climbed to a four-year high. The number of foreclosures jumped to its highest level since the survey started 37 years ago, driven by the subprime market.
"The lesson we've learned is that some traditional rules of thumb still apply," said Greg McBride, senior financial analyst at Bankrate.com, a personal finance Web site. "Just because a lender lends you money, that does not mean it's a wise decision to take it."
Many borrowers took the money because they could not afford homes otherwise. But when they began missing payments, their lenders suffered huge financial setbacks. More than two dozen such lenders have shut down or been acquired since December.
Some lenders are tightening up, which means "it will be tougher for subprime borrowers to get credit, and I expect all subprime borrowers can expect to pay higher rates," McBride said.
On the flip side, because of the turmoil, investors who sank money into the subprime market are now fleeing to the prime market, which makes up a majority of mortgage lending. "All this hubbub about subprime mortgages has increased the demand for mortgage debt of top-quality borrowers and reduced the rates those borrowers pay," McBride said.
Some of the publicity has focused on adjustable-rate mortgages, particularly those with low teaser rates that "reset" in later years. A study by First American CoreLogic found that trillions of dollars worth of these types of mortgages are going to reset in 2007 and 2008 or have begun to do so.
Christopher Cagan, the group's research and analytics director, said he expects 1.1 million reset-related foreclosures within the next seven years. Those would represent 13 percent of adjustable-rate mortgages for purchases or refinancing from 2004 to 2006 -- or $326 billion. About $112 billion will be lost when those homes are resold, he estimated.
The losses won't break the economy because they represent less than 1 percent of total mortgage lending, the study concluded. But subprime borrowers will be hit hard. About 12 percent of them are expected to default due to resets.
All this upheaval does not mean an end to nontraditional loans because some of them make sense in certain situations, said Charles N. Vance, an area manager for Wells Fargo Home Mortgage.
But before signing on for one, think about how long you are likely to live in the home you're buying, Vance said.
"If you're leaving the area in three years after graduating from law school, then you might go with a product that would lock in a rate for three years," even if the rates jump later.
Whatever the choice, "don't commit to a mortgage payment based on your best year, knowing that the next year might be worse," he said.