Now a study by the Government Accountability Office says new standards of consumer education should be required for “alternative mortgage products” or “AMPs” — that’s a fancy term for interest-only loans and option ARMs.

What’s the problem?

Today’s paperwork simply does not work with interest-only and option ARMs. For instance, a typical disclosure statement might say that monthly payments may rise or fall. Such language is literally true — but artfully does not disclose the magnitude of potential payment increases, the idea that monthly payments might double in a few years.

Federal rules at this time do not require special disclosures for interest-only mortgages or option ARMs. Ads for such loan products often focus on low-up front costs rather than all loan terms. When higher monthly costs kick-in borrowers may be faced with stark and unexpected financial choices.

“Although AMPs have increased affordability for some borrowers, they could lead to increased payments or ‘payment shock’ for borrowers,” says the GAO.

The result for many borrowers is that “unless the mortgages are refinanced or the properties sold, AMPs eventually reach points when interest-only and deferred payment periods end and higher, fully amortizing payments begin.”

But what if loans cannot be refinanced? What if properties cannot be sold for enough to pay-off bigger loan balances? As we are seeing, home values do not always rise.

“Many buyers are purchasing with little or nothing down,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the largest online marketplace for foreclosure properties. “Buyers with nontraditional financing in a slow or declining market could easily find themselves with a home which has actually lost value while the mortgage balance has grown substantially.

“After a few years a buyer could be stuck with unaffordable monthly costs plus a home that cannot be sold for enough money to pay off the mortgage. When you look at the risks associated with interest-only mortgages and option ARMs — loans that together now represent more than 70 percent of all new mortgage originations — you have to wonder why more disclosure is being studied and debated when the immediate need is obvious.”

Once “start” rates for interest-only and option ARMs end a significant number of borrowers will be unable to make monthly payments. How many borrowers? No one knows.

“Because the monthly payments for most AMPs originated between 2003 and 2005 have not reset to cover both interest and principal,” explains the GAO, “it is too soon to tell to what extent payment shocks would result in increased delinquencies or foreclosures for borrowers and in losses for banks.”

Put it all together and you have armies of borrowers with loans they don’t understand. In too many cases, you also have borrowers with loans they will be unable to repay.

A borrower with option financing can typically make monthly payments sufficient to amortize (pay off) the loan in 30 years. Or, by making bigger monthly payments, the borrower could pay off the entire loan in 15 years.

Alternatively, option financing also allow the borrower to make interest-only payments during the first few years of the loan term. Lastly, option financing allows borrowers to make low payments during the first years of the loan that do not even cover the cost of interest. The interest not paid is added to the loan balance each month, a process called “negative amortization.” Of course, as the debt grows so do interest costs.

The GAO offers this example:

Someone gets a $400,000 option ARM. The loan has a 4.41 percent initial interest rate, however during the five-year start period the borrower can pay as if the interest level is just 1 percent. Required monthly payments during the start period can be increased no more 7.5 percent a year.

Here’s how the monthly payments and loan balance change for a borrower who only makes the minimum payment.

If you look at the chart you can see that by the start of the sixth year the monthly payment has more than doubled. However, an option ARM is an adjustable-rate loan product. The chart assumes that the interest rate does not change. In the real world, the interest rate over a five-year period could easily rise or fall. If it falls, no problem. If rates rise, then negative amortization could increase substantially and future monthly payments would rise sharply.

“There’s no reason lenders cannot offer clear and concise brochures that explain the pros and cons of nontraditional financing,” says RealtyTrac’s Saccacio. “Such disclosures could detail how interest-only and option ARM financing increase affordability. With equivalent space and the use of clear charts and graphs the same brochures could also describe the potential costs and risks.

“Current loan disclosure forms do not fully outline the potential risks associated with interest-only mortgages and options ARMs,” he continued. “Even if borrowers read today’s disclosure forms from end-to-end they will not find needed loan information or illustrations. The result is more risk for borrowers — and that means more and unnecessary risk for lenders and mortgage investors.”

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Published originally by RealtyTrac.com during October 2006 and posted with permission.

It’s Time To Raise Loan Disclosure Standards is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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Answer: The matter of “as is” sales has evolved during the past decade or so. The best advice used to be “caveat emptor” –- buyer beware, but now it is both buyer and seller use care.

The issue here is that you can plainly sell a home on an “as is” basis. At the same, many would argue that “as is” does not mean a seller has a license to simply sell a damaged property to an unwary buyer. In general, owners must disclose what they know about a property even in an “as is” sale situation.

Given the current trend, sellers wishing to sell on an “as is” basis should take several steps.

First, require the buyer to obtain an independent home inspection with an inspector selected, hired and paid for by the purchaser. In exchange for the right of the inspector to enter the property, require the buyer to give you a copy of the completed inspection for your records. Keep this document with your closing papers.

Second, “as is” requirements vary by state. Depending on the state, either a real estate broker working with language from an attorney or an attorney directly should write a proper “as is” clause. This clause should be written to “survive” closing (have standing after the sale is completed and the matter goes to court).

Third, properly and fully complete any required seller disclosure form to the best of your ability. Review with a broker or attorney – this document should be seen as relating to the “as is” agreement.

Fourth, if you are not living in the property, see if it can be sold as “commercial” real estate. An attorney can explain if this is possible and the advantages which might be available in a given jurisdiction.

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Syndicated originally by Content That Works and posted with permission.

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“Yes,” say the buyers, “we want this house.”

“Fine,” say the owners, “here’s our seller disclosure form written by our state government which requires that we tell you all we know about the property.”

Should not the purchasers feel a wave of confidence at this moment? After all, the owners are providing a state-mandated disclosure form which surely covers every possible issue regarding the property’s condition.

Right….

Let us assume that the owners in this instance are utterly honest people who want to assure that the buyers fully understand the property and it’s condition. And so, as the sellers explain above, they have surely told all they know about the property.

And therein lies the problem. The owners are great people, totally honest, but they may not know too much — or anything — about the property, or at least anything about the stuff that counts.

You ask the owners: “Have you been in attic during the recent rain storms?”

They say, “huh.”

To the best of their knowledge — and these are entirely honest people — the roof does not leak. But you have to wonder, how can they possibly know if the roof leaks if they have not been in the attic?

You look at the form prepared by your friendly and ever-helpful state government and you ask: Can anyone answer such questions?

My favorite question comes from Virginia.

“Are there any substances, materials, or environmental hazards (including but not limited to asbestos, radon gas, lead-based paint, underground storage tanks, or other contamination) on or affecting the property?”

One phrase which interests me is the one about conditions “on or affecting” the property. How are owners to determine if an underground storage tank is buried in a neighbor’s yard. Is it okay to drill? Do you need the neighbor’s permission? Is it okay to ask neighbors if basement radon accounts for those additional fingers? Can an owner be liable for not knowing what they cannot know?

And what about the expression “but not limited to.” Is there any end to the possible liabilities represented by this phrase? For instance, is it the owner’s responsibility to detect a spot of mold behind the built-in dishwasher? Must a home be disassembled before sale to check for deficiencies?

When mandated disclosure forms first began appearing a decade ago they were designed to protect three groups:

Owners — so there would be a written record showing that sellers had correctly disclosed information regarding the property’s condition.

Buyers — so they would better understand the property they were purchasing.

Brokers — so they would have paperwork to demonstrate that property disclosures had been made. In other words, liability protection.

In theory, property disclosures are a great idea, but state-mandated forms may not ask the right questions, the questions may be literally unanswerable, and owners may be wholly unqualified to respond.

I am not among those who believe that buyer abuse should be a marketplace reality or that caveat emptor is a fair standard for real estate dealings. And yet it is fair to say that the marketplace has changed since state-written seller disclosure forms were introduced.

For instance, professional home inspections are both common and widely available. Buyer brokers are available nationwide. The use of limited home warranties is widespread.

I have grudgingly and with considerable reservation come to the conclusion that the time has come to dump mandated seller disclosure statements.

Why?

Seller disclosure statements provide assurance where none is earned. They are incomplete at best, misleading at worst. Most disturbingly, buyers may see them as a cheap way to avoid a home inspection.

In terms of reducing broker liability, seller disclosure forms serve merely as checklists for attorneys, paperwork that can be used against brokers even though brokers are not the authors of such documents.

I am aware that anything called “consumer protection” immediately and instantly has widespread support, but seller disclosure forms need to be re-thought because ultimately consumers will be better off turning to the new protections which have emerged in the marketplace.

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Published originally by Realty Times on March 13, 2001 and posted with permission.

Is It Time To Dump Home Seller Disclosures? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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“As is” clauses should be seen as an absolute requirement to make the transaction contingent on a professional inspection “satisfactory” to you. With a properly written sale agreement contingency, if you are not satisfied, then the deal is dead and you can get back your deposit in full.

Rules for “as is” sales vary extensively. In some jurisdictions, even with an “as is” sale, owners must disclose known material defects.

Please speak with your broker and/or attorney for details.

What’s An “As Is” Sale? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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The reasoning behind such disclosure rules is that brokers and salespeople, by virtue of the fact that they are licensed, are presumed to have a marketplace advantage over those who have not studied real estate, passed various tests, and obtained a license. To have a fair playing field, brokers and salespeople must disclose the fact that they are licensed so that consumers know about such training and experience.

For specifics, speak with brokers regarding disclosure requirements in your state.

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But, a seller disclosure form is not a substitute for an independent examination by a professional home inspector. A seller may well complete a form to the best of his or her ability, but without a knowledge of home construction that ability may be limited. And, a state-written form may not ask the questions you want answered.

For example, when was the owner last in the attic to check for leaks? When was the furnace last examined? Does the home have aluminum wiring? Etc.

Do I need A Home Inspection If I Have A Seller’s Disclosure Form? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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The wording here is curious. If this is a “mandatory” refund then how come I “may” receive it? Should it not automatically go to my bank account? Isn’t that what “mandatory” means? And about that $5,100.00 — why is that number in bold if I might receive less? After all, a “refund up to” is hardly the same as a plain old “refund.”

If you read the fine print at the bottom of the letter — and for me that means whipping out a magnifying glass — it says “recipients of this letter do not necessarily have FHA-endorsed mortgages, and may or may not be entitled to a refund.”

But the fact is that you don’t have to depend on a helpful merchant to get an FHA refund. If you’ve ever had an FHA loan you may be entitled to a partial rebate of the mortgage insurance premium. Maybe not much and maybe nothing at all but you can easily find out without sending money to me or anyone else — just go to HUD’s online refund page.

A lot of folks are getting fed up with the mortgage come-ons whether they appear in the mail, the paper or on television. In California, Assembly Member Alberto Torrico has just introduced AB 941, legislation which would require lenders who offer option ARMs and negative amortization loans to plainly spell out important terms. If the Torrico bills passes lender offers would be required to say in big print that the “advertised rate of ____ is not the actual interest rate. It is the payment rate. If the borrower chooses to pay this advertised rate, the principal balance of the loan will increase.”

But while Torrico says there ought to be a law, a federal judge in Wisconsin says there is already such legislation in place.

Susan and Bryan Andrews of Cederburg, WI thought they were getting a good deal when they decided to accept a loan that would be funded by Chevy Chase Bank, a major financial institution in the Washington, DC area.

According to federal district judge Lynn Adelman, the Andrews “believed that the payments and the interest rate were fixed for five years and became variable thereafter. However, although the minimum monthly payment was fixed for five years, the interest rate was not. The loan carried a discounted or “teaser” interest rate of 1.950 percent, but that rate applied only to the first monthly payment, after which the interest rate increased every month according to a formula.”

The question before Judge Adelman was whether the Andrews could begin a class-action suit against the lender under the Truth in Lending Act (TILA). Adelman said yes and now as many as 7,000 borrowers may be involved.

It turns out that under the TILA there are many standards which must be met when mortgage products are advertised and originated. Here are some of the points made by Judge Adelman in her decision.

• “All required disclosures must be clear and conspicuous.” If language can be read in more than one way then under TILA it’s not clear.
• “Information concerning the number, amount and periods of payments must be disclosed clearly and conspicuously.” Lenders must group such information. They must also “conspicuously” segregate it “from all other terms, data, or information provided in connection with a transaction.” Information may be shown conspicuously by using bold print, placing it in a box, etc.
• Small print may not be sufficiently conspicuous to meet TILA requirements.
• Disclosures must be consistent and not contradictory or misleading.

“TILA does not require a lender to disclose a loan’s interest rate,” said Adelman. “Further, in the present case, defendant was most assuredly not required to disclose the 1.950 percent rate, which applied only to the first monthly payment. However, as discussed, defendant included the 1.950 percent rate on its TILDS. Yet the 1.950 percent figure had virtually no relation to any information required to be disclosed on the TILDS, much less a direct relation. The 1.950 percent rate had no significant connection to the cost of the loan. Moreover, a reference to the 1.950 percent rate would not be useful to an ordinary borrower because it would cause the loan to appear more attractive than it actually was and serve no useful purpose.”

While Judge Adelman has placed a stay on her ruling so that it could be appealed, if her initial decision stands it means that the case may be continued in the form of a class action suit. While Adelman said that the Andrews were not entitled to statutory damages, they can seek rescission and attorneys’ fees. If they’re able to obtain a rescission order from a court, borrowers will be able to demand the return of money paid to the lender to date.

“Whether Judge Adelman’s decision goes further in the court system or not, it at least makes two points,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the nation’s largest foreclosure resource. “First, borrowers need to understand all terms before entering into a mortgage agreement. Second, lenders need to spell out loan terms with clarity. Meanwhile, you can bet that as a result of the Andrews case a lot of lenders are reviewing marketing materials and loan documents to make sure they meet all required standards.”

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Published originally by RealtyTrac.com during March 2007 and posted with permission.

Mortgage Marketing: There Ought To Be A Law…. is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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It’s been a very good century for real estate, at least so far. According to the National Association of Realtors, the typical home that sold for $139,000 in 2000 was worth $208,700 in 2005.

Not only have home values increased, unit volume has also grown. There were 5,152,000 existing home sales in 2000 compared with 7,072,000 in 2005. The National Association of Home Builders says new home sales rose from 877,000 units in 2000 to 1,285,000 in 2005. Average sale prices increased from $207,000 to $295,100 during the period.

If you do the math you see something else: Home sales involve a lot of money. The gross market, units x cost, was $897.7 billion in 2000 versus $1.78 trillion in 2005.

While everyone likes to see increased sales, these numbers hide an impending problem. Homes which may have been affordable in 2000 were less affordable in 2005. In fact, in February the NAHB/Wells Fargo Housing Opportunity Index reached a record low — “only 41% of new and existing homes that were sold during the final quarter of 2005 were affordable to families earning the national median income.”

So how is it possible that sales and prices are at record levels while affordability is in the ditch?

The answer for large numbers of buyers is that they bought real estate with the presumption that monthly costs — not purchase prices — were the key to future wealth.

Essentially the strategy has been this: Since real estate was presumed to be an eternally-appreciating asset, it made sense to buy as much as possible. For instance, if values are going up 10 percent a year buyers benefit by purchasing a home priced at $500,000 rather than $300,000. Why? Because at the end of the year their equity would have increased by $50,000 rather than $30,000.

With such thinking, what counts are monthly costs. The concept is to buy, hold for a few years and then sell. Even better, buy, flip the contract, pocket the cash, and do it again.

If you look at the numbers you can see that for many buyers the pricing gamble has been a huge success during the past few years. Home values have risen substantially in most areas. The odds are overwhelming that if you bought in 2000 or before and sold in 2005 or thereabouts you made money. A lot of money.

But looming in the background is the potential for financial disaster that will impact home values nationwide, spur foreclosure rates to new highs and devalue insurance funds, pension holdings and investor accounts. The value of your home, no matter how you financed, is at stake.

How could such a good plan go wrong?

The whole theory of wealth accumulation as it has been practiced for the past few years relies on two constants: Home values must rise and monthly payments must remain affordable. Unfortunately, neither constant is assured.

Home Values

If it happens that appreciation slows that’s not an instant issue. Most owners at any given time do not want to sell and do not have to sell as long as payments are affordable or the property can be rented on at least break-even basis.

However, prices do become a problem if appreciation slows and weaker owners begin to unload their properties because they cannot carry the monthly costs. A cascade effect sets in: Seeing that values are not rising, owners with shaky financing begin to sell. Marketplace inventory increases. More inventory creates additional supply at the moment of slower demand. As prices slow or actually fall, more units become available for rent. Rental rates fall and an increasing number of investors seek a way out.

You can see the changes by tracking local MLS statistics: Average days on the market will increase. Average appreciation will slow or decline. The number of units for sale will grow. Sale prices as a percentage of list prices will decline.

Or you can just look in the paper.

In my area there have been recent builder ads offering homes with discounts of $70,000 to $100,000.

These ads are enormously important because many small investors have purchased condo units and new homes. They buy when projects are first announced and then hope to sell as the property is built out and builder prices rise.

However, if builders are offering discounts it means that contract holders and recent buyers must now compete with developers who are offering like units at lower prices. The only options are to hold properties and hope for higher prices or sell at a loss.

Monthly Payments

The new theory of investment has been to get in and get out quickly. Since values always rise under the new thinking, pricing doesn’t matter as long as monthly payments are as low as possible. However, if values stagnate or actually decline, then properties must be occupied, rented or sold.

Across the country we now see a general softening of prices. NAR reported that in January the median price for an existing home was $211,000, up 11.6 percent from a year earlier. In February that same home sold for $209,000, up 10.6 percent from 2005. In other words, prices fell from January to February.

Some will say that month-to-month price changes are irrelevant, but that’s not how the game of expectations is played. Can you picture a buyer broker telling a client, “well, you know now is the time to buy, before the price of the home drops any further.”

The public during the past few years has come to expect rising home prices; any change from the accepted script is troubling. However, lurking below the surface are those monthly payments.

The issue is not that ARMs or interest-only loans are new, it’s that they’re available to a larger percentage of borrowers than in the past.

Monthly payments are not an immediate financial issue for 40% of U.S. homeowners, those who hold property free and clear.

Nor are changing payments a concern for those with fixed-rate financing. According to the Mortgage Bankers Association, half the loans originated in the first six months of 2005 were fixed-rate products.

And the other half?

Adjustable-rate loans — excluding interest-only products — represented 34 percent of all mortgages originations for the period, says MBA.

MBA divided interest-only loans into two categories, fixed and adjustable. Fixed-rate interest-only loans represented 2 percent of all originations in the study while adjustable interest-only loans amounted to 14 percent.

When you look at the dollar amounts, however, the study shows something different. Fixed rate loans are 40 percent of all originations, ARMs are 36 percent and interest-only products are 23 percent. The dollar value of adjustable interest-only loans is more than 10 times greater than fixed-rate interest-only products.

In other words, riskier ARMs loans are disproportionately larger than typical fixed-rate mortgages. Equally important, fixed-rate loans are disappearing.

According to a recent Federal Reserve study the use of fixed-rate financing is declining at a rapid rate. As the Fed explains, “roughly 85 percent of first mortgages were fixed-rate in 2001, slightly more than 10 percent were adjustable-rate, and the rest were balloon.” Now, of course, fixed-rate loans by dollar value are just 40 percent of all originations.

You can also see more risk in the marketplace in terms of qualification standards. As an example, consider FHA financing. Qualifying ratios last April went from 29/41 to 31/43. You have to wonder why this happened: Do you think borrowers now represent less risk? Or, could it have anything to do with the decline in FHA originations, from 1.53 million in 2003 to 556,000 in 2005?

Perhaps the FHA revised its standards because incomes are up. Whoops, that can’t be right. According to the Census Bureau, real household income — money expressed in terms of buying power — actually has declined since 1999.

But FHA mortgages are not a core concern. Instead, we need to look at stated-income loans, option or hybrid ARMs, interest-only mortgages, and excess equity financing. These are the financing options of choice for today’s real estate gamblers — those who buy property on the basis of monthly costs.

Between 1990 and 2003 interest rates fell overall. ARMs were generally safe because principal was being reduced and interest levels, by and large, were falling. Figures from the Federal Housing Finance Board show that the national average contract mortgage rate stood at 13.74 percent in May of 1980 and reached 5.34 percent in July 2003.

But rates have been rising from the lows seen in 2003 and we will soon see if the presumptions which powered risky mortgages are correct. Let’s look at the four types of loans most likely to fail.

1. Stated Income Financing

Historically lenders have been extremely concerned with loan application data. For many borrowers, it seemed that getting a national security clearance required fewer verifications and less paperwork than a new mortgage. But with “stated income” loans we have a new theory: We check credit scores and tell borrowers that whatever income they claim will not be verified.

The result is that with stated income financing a loan officer might say: “Mrs. Johnson, you have certainly found the home of your dreams. I can easily see how you and your family will really enjoy this house. We can finance your lovely home with a stated-income loan. With this type of financing you tell us how much you earn and we will not check. To buy this wonderful property you need a household income of $90,000 a year to qualify. So tell me Mrs. Johnson, how much is it that you earn each year?”

What do you think Mrs. Johnson will say?

Unfortunately, the loan officer did not tell the whole story. Stated income loans are sometimes examined when loans are packaged, sold and audited. And if a home is foreclosed, do you think a lender will not review the application?

2. Option or Hybrid ARMs

Option loans are ARM products where during the first three, five or ten years borrowers can pay on the basis of four choices: A fully amortizing payment that will retire the loan in 30 years, a higher payment that will amortize the loan in 15 years, an interest-only payment, or a low, low payment that creates negative amortization and adds to the loan amount. After the initial phase, the mortgage typically becomes a one-year ARM for the rest of the loan term.

Imagine that you have a $300,000 option loan. The margin is 2.75 percent and the 11th District COFI index is 3.347. We’ll say the initial rate is 1.25 percent and the annual rate cap is 7.5 percent.

Here’s what happens with a $300,000 option loan: The minimum payment is $997.78. The interest-only payment is $1,524.25. The 30-year amortizing payment is $1,817.40. The 15-year amortizing payment is $2,547.32.

If our borrower makes minimum payments then in month #60 the loan balance will be $328,812 and the monthly payment will be $2,284. These numbers assume that the interest rates have not soared. But what if the rate goes to 7 percent or 7.5 percent or 8 percent? By historic standards, these are not high interest levels.

Of course, the owner can sell. But after five years the loan balance has increased. Hopefully the value of the home has also gone up and is greater than the remaining mortgage debt. But as I tell folks, there are no stone tablets which say the value of real estate must rise.

3. Interest-Only Loans

Interest-only loans can be fixed-rate or adjustable mortgage products where the borrower’s debt never increases. However, during the interest-only payment period, typically the first five years of the loan term, the debt never falls.

The risk here for lender and borrower is two-fold: First, monthly payments can rise for those with adjustable rates. Second, once the loan begins to amortize the payment can rise significantly.

Consider a $500,000 interest-only with a 6.5 percent fixed rate. In the first five years the monthly payment for principal and interest is $2,708. For the next 25 years the payment is $3,376.04, a higher payment created by the fact that the remaining loan term has been reduced to 25 years.

4. Excess Equity Loans

Excess equity loans allow borrowers to obtain financing equal to more than the appraised value of a property — 104 percent, 107 percent, 110 percent, 125 percent and even 145 percent. Plainly the interest rates for such financing soar as the loan becomes increasingly unsecured, but this has not deterred borrowers.

If you look at the four loan options discussed here you notice they all have a common root: Borrowers have good credit and qualify on the basis of short-term calculations.

But the loan which is affordable at $998 a month may not be affordable at $2,300 a month. No less important, mortgage payments do not exist in isolation. Borrowers may also face ballooning utility bills as well as rising property taxes.

The Coming Storm

We now have a situation where stated income loans, interest-only financing, option ARMs and excess equity loans have begun to season. That means we will soon begin to see more and more of these mortgages convert to phase two, a time when monthly payments must be substantially higher to amortize the loan.

The result is that a growing number of recent property owners will find that they have homes and investments which cannot be sold at a profit — as well as homes and investments which cost too much to carry. The fruits of this impossible dilemma will be more properties for sale, more supply, more pressure to moderate if not lower prices, more foreclosures and more bankruptcies. Even those without a mortgage may find that the value of their home will drop as neighbors who financed imprudently rush to dump their properties on the market.

How substantial is this problem? USA Today has reported that an estimated 7.7 million adjustables have been issued in the past two years — and that up to 1 million may wind up in foreclosure during the next five years as a result of rising monthly costs. (See: “Some homeowners struggle to keep up with adjustable rates”, April 3, 2006)

According to the Mortgage Bankers Association the percentage of homes being processed for foreclosures at this time is about 1 percent of all loans. If the projection reported by USA Today is correct, then we’re looking at a foreclosure rate for recent ARMs — the loan category which includes most toxic mortgage products — that’s 13 times higher than normal.

John C. Dugan, the Comptroller of the Currency, framed the issue this way last December:

“Too many consumers have been attracted to products by the seductive prospect of low minimum payments that delay the day of reckoning, but often make ultimate repayment of growing principal far more difficult.”

“At the same time, too many lenders have been attracted to the product by the prospect of booking immediate revenue without receiving cash in hand, a process that often masks underlying credit problems that could ultimately produce substantial losses.”

“Is this an appropriate product,” Dugan also asked, “to mass market to customers who may be looking at the less than fully amortizing minimum payment as the only way to afford a larger mortgage — at least for the five years before the onset of payment shock? And are lenders really prepared to deal with the consequences — including litigation risk — of providing such products in markets where real estate prices soften or decline, or where interest rates substantially increase?”

The problem with regulatory concerns at this point is that huge numbers of non-traditional loans have already been issued. Surely this matter would have been better addressed several years ago, when toxic financing was relatively rare and the stakes far smaller.

But we must deal with what is rather than what might have been.

High-risk loans have allowed many individuals to buy property who might otherwise not have the chance, thus increasing demand and pushing prices higher. And in many cases high-risk loans have enabled borrowers to make substantial profits.

But at no time has the marketplace been without risk. Today, more than in the past few years, we see a market in transition. For those who assist buyers and borrowers the question regarding toxic loans is this: Are individuals really being helped with financing which allows them to buy property today — but may lead to financial distress tomorrow?

Over the years one of the most helpful trends in real estate has been the expanded use of disclosures and waivers. They protect consumers — and they also protect brokers and lenders.

And so I would make a modest suggestion: A few minutes of consumer education should be the responsibility of every broker and every lender. In other words: disclosure and waiver. All it takes is some discussion and a few print-outs which show projected monthly payments for several baseline mortgages: Say a 30-year fixed, 3/1 ARM, 5-year interest-only loan and option ARM financing. The material should at least cover the start-rate periods plus the next two years. The best case and the worst case scenarios should be shown.

In addition, consumers should be plainly told that interest rates can rise, that increases in home values cannot be guaranteed, that past performance does not assure future results and that information provided for stated income loans must be verifiable — just in case the loan file is ever audited.

And for the protection of brokers and lenders it would be a good idea to get a signed and dated receipt showing that the information was provided.

Does anyone doubt that consumers need such information? A study released in March by the Federal Reserve explains that “in 2005 the payments on many ARMs were governed by ‘option’ or ‘hybrid’ features that were largely unknown in 2001.”

The Fed report also shows that 35 percent of all ARM borrowers do not know how much payments can rise month to month and 41 percent don’t know the maximum interest level for their loan. For that matter, 20 percent didn’t know the original rate for their ARM.

The idea of better explaining newly-emerging loan concepts is not to drive away buyers and borrowers, rather it’s to assure that consumers have a strong stake in the homeownership process. While toxic loans may produce sales in the short term, they may also demolish long-term notions of value and benefit that are essential to real estate.

In the same way that mandatory disclosures regarding agency and condition were first opposed, I expect that the notion of toxic loan disclosures and waivers will also generate little support.

The alternative is that one day foreclosed homeowners will turn around and take brokers and lenders to court claiming they knew full well that borrowers could not afford inevitably higher payments and that, essentially, they engaged in the encouragement of default. The motive: Quick commissions and fees.

Think it can’t happen. Think jurors won’t buy it? Are you willing to bet your company and your career on the answer? Somehow disclosure seems a lot more attractive.

Toxic Loans: The Coming Storm is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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