BLOG VIEW: Could the strange, exotic and often risky loans that were originated in the run-up to the mortgage meltdown make a comeback? You know, the loans widely introduced after 2000 – the financing with ‘gotcha’ clauses, little or nothing down and loan applications that were shorter than a candy wrapper?
The answer is yes, sort of – but before anyone panics, let's understand that these are not the toxic loans of old. Instead, they're new – and plainly, saner – approaches to creative financing.
The mortgage marketplace is far safer today than it was before the mortgage meltdown. Figures from RealtyTrac show that foreclosure starts hit a 10-year low in the first half of this year, meaning that borrowers and lenders can finance and refinance homes today with remarkably little worry.
The low level of risk associated with mortgages explains, in part, the rates we're seeing today. Mortgage rates are at roughly 4% or so, as of this writing – a figure that is obviously much higher than the 3.31% seen in 2012 but less than half the 8.6% average of the past 40 years (as per Standard & Poors).
The low levels of risk also mean that this is a market in which lenders can do very well. First, Equifax reports that this year is shaping up to be a booming year for mortgage originations.
Total mortgage origination balances, says Equifax in a recent report, hit $466 billion in the first quarter – a 74.4% increase over the same time a year ago. First, mortgages led the growth, jumping 79.9% versus the first quarter of 2014 to $430 billion, while originations of home equity lines of credit rose 30% to $30.9 billion and new home equity installment loans climbed 13.6% to $5.0 billion.
Second, the loans being made are hugely profitable. In fact, profits have almost doubled.
‘Independent mortgage banks and mortgage subsidiaries of chartered banks reported a net gain of $1,447 on each loan they originated in the first quarter of [this year] – up from a reported gain of $744 per loan in the fourth quarter of 2014,’ says the Mortgage Bankers Association.
Although the real estate market is doing better by most accounts, it still remains fragile. Household income is lower than in 1999, and that constrains prices and monthly payments. Most importantly, if interest rates rise significantly, perhaps as a result of a Fed rate hike, the impact on the marketplace could be significant.
‘Even a modest rise in mortgage rates could price many potential buyers out of the market, particularly with many younger, first-time buyers carrying a great deal of student loan debt,’ says Wells Fargo.
Seeing as we have both better times and lots of potential buyers, the natural question is whether we can push the market a little further with the re-introduction of non-traditional mortgage products such as interest-only loans, option ARMs and loans with no-doc loan applications.
‘Because it was drafted primarily to prevent a repeat of the kind of lending practices that led to the housing market meltdown, it's not surprising that, Dodd-Frank has a few choice words to say about non-traditional loan products,’ says Rick Sharga, executive vice president at Auction.com. ‘An interest-only loan can't be a qualified mortgage, or QM, because it lacks substantially equal payments. An option ARM won't fit within the QM category if it allows negative amortization. Under the ability-to-repay rule, no-doc and stated-income loan applications are no longer possible with any residential mortgage.’
But what about loans that are non-QMs or financing that does not fall within the qualified loan definitions?
Jumbo mortgages, for example, are non-QMs and are entirely common. Lenders tend to offer these to high-net-worth borrowers who they can sell other banking services to. If you have the credit and resources, you can get a jumbo.
As another example, interest-only loans can work as non-QMs, provided they meet the ability-to-repay (ATR) rule, meaning the lender verifies the borrower's income or assets. Today, such loans are likely to require 20% down and a strong credit standing.
For a third example, imagine that you get a $250,000 interest-only loan at 4%. The loan is a 5/1 ARM, so the initial payment is set for the first five years of the loan term. After five years, the loan can adjust up or down, but it cannot rise more than 2%.
How does this loan work in practice? Suppose that during the first five years, the monthly interest-only payment is $833. If the new rate is 5%, after five years, then the payment jumps to $1,461. The payment could actually increase to $1,611 if the rate rises to 6%, the maximum allowed with the first adjustment in this example.
Even if the rate stayed at 4%, the monthly payment would still rise to $1,320 at the first adjustment. This happens because the loan has now started to amortize. The balance after five years is still $250,000, and there are only 25 years left in the loan term. With less time to pay, the monthly cost goes up.
Alternatively, a borrower might just get a 30-year, $250,000 fixed-rate loan at 4%. The monthly cost for principal and interest would be $1,194 for the life of the mortgage. That's a higher upfront cost when compared with the interest-only product, but could potentially be a lot lower than possible interest-only payments down the road.
‘Most lenders are reluctant to take on any risk today, which means that very few are willing to make loans outside of the QM rules,’ Sharga says. ‘But it's not entirely clear that borrowers would flock to these loans, even if they were more available.’
In fact, borrowers are largely sticking to the most mundane loans they can find. Research by the National Association of Realtors estimates that non-QMs comprised just 1.2% of the loan market in the first quarter – not a surprise in the new world of solid down payments, big credit scores and hefty document requirements.
Peter G. Miller is a nationally syndicated real estate columnist. His books, published originally by Harper & Row, sold more than 300,000 copies. He blogs at OurBroker.com and contributes to such leading sites as RealtyTrac.com, the Huffington Post and Auction.com. Miller has also spoken before such groups as the National Association of Realtors and the Association of Real Estate License Law Officials.
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