Now Wall Street is our financial Vietnam. It’s broken. The old cures and postponements won’t work. Everyone knows it.

“High risk mortgage lending and shortcomings in consumer protections for mortgage borrowers were among the most important underlying causes of the housing bubble and the financial crisis that resulted,” according to Sheila Bair, past chairman of the FDIC. “Not only did the proliferation of high-risk subprime and nontraditional mortgage products help to push home prices up during the boom, but excessive reliance on foreclosure as a remedy to default have helped to push home prices down since the peak of the market over four years ago.”

No longer are huge financial corporations seen as too big to blame — nor as too big to fail. In fact, some have even embraced the idea of a voluntary bankruptcy.

• Stock values for the financial sector are in the dumper. Shareholder equity worth hundreds of billions of dollars has been destroyed.
• The value of savings has been demolished with interest rates at record lows. Those who had played by the rules and put away for retirement now find themselves with pension cash that generates only tiny dribbles of income and surely less than the rate of inflation. In effect, savers are losing buying power. Many who were once financially comfortable are comfortable no more. Government, corporate and private pension plans have all been decimated.
• According to the FDIC the banking industry had profits of $28.8 billion in the second quarter — after reducing reserves for loan losses by $21.5 billion when compared with a year earlier.
• Large and growing demonstrations are taking place in New York, Seattle, Boston and Washington. Groups such as Occupy Wall Street, Occupy Together.org, Occupy DC and TakeBackBoston are rising with the speed of Twitter, texting, Facebook and Google.
• A huge march for jobs and justice is scheduled for October 15th in Washington. Major unions and other organizations will be involved, according to the National Action Network.
• Sweetheart deals between banks and regulators are falling through. The Federal Housing Finance Agency is now suing 17 major banks and servicers, alleging that mortgages worth nearly $200 billion were sold to Fannie Mae and Freddie Mac through “negligent misrepresentation.”
• An effort to paste together a $20 billion robo-signing settlement between several major banks and the nation’s 50 attorneys general is on the rocks. Several state AGs — including New York’s Eric Schneiderman and California’s Kamala Harris — oppose a general settlement which would allow banks and servicers to avoid further mortgage and securities investigations.
• Michael Hudson, author of The Monster: How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America–and Spawned a Global Crisis, alleges that lenders have “protected fraudsters by silencing whistleblowers” in his new two-part series, The Great Mortgage Cover-Up.
• The real size of the 2008 bailout is beginning to be understood. It wasn’t just a $700 billion line-of-credit, it was also secret funding worth $1.2 trillion according to Bloomberg News. “The largest borrower, Morgan Stanley (MS), got as much as $107.3 billion, while Citigroup took $99.5 billion and Bank of America $91.4 billion,” says Bloomberg, which had to sue to get the information. (See: Wall Street Aristocracy Got $1.2 Trillion in Secret Loans, August 22, 2011)
• Across the country foreclosures have slowed, not because there are more jobs or better times but because the electronic sale and transfer of mortgage notes is widely regarded as unreliable. As the Maine Supreme Court explained to one lender, their documentation was “inherently untrustworthy.”

Gutting Regulation

In even in past periods when unemployment has been high there was no mortgage meltdown that compares with what we have seen since 2007, the year home prices peaked.

So what happened?

The presidency of George W. Bush was powered in large measure by an effort to reduce both taxes and government regulation. The compassionate conservatism he promised — whatever that was — quickly was replaced with the thinking of Ayn Rand.

“When I say ‘capitalism,’” said Rand, “I mean a full, pure, uncontrolled, unregulated laissez-faire capitalism — with a separation of state and economics, in the same way and for the same reasons as the separation of state and church.”

Indeed, officials from five financial regulatory agencies told reporters in 2003 they were going to “identify and eliminate outdated, unnecessary or unduly burdensome regulations imposed on insured depository institutions.” To make sure no one misunderstood, four of the regulators stood around a pile of paperwork with pruning shears. The fifth, James Gilleran with the Office of Thrift Supervision, posed with a chainsaw.

The Securities and Exchange Commission decided in 2004 that 11 major banks and brokerages could have more liberal reserve requirements than competitors. The SEC said “the 11 firms we expect to apply under the rule amendments could realize a total reduction in haircuts of approximately $13 billion. We estimate that they will realize a total annual benefit of approximately $26 million (.2% * $13 billion = $26 million).”

How nice to give selected corporations a $26 million advantage. That sure sounds like a case of the government picking marketplace winners.

In fact, according to The New York Times, much more that $26 million was involved.

“The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.” (See: Agency’s ’04 Rule Let Banks Pile Up New Debt, October 2, 2008)

Federal Monopoly

In 2004, one major bank regulator, the Office of the Comptroller of the Currency (OCC), simply ruled that state regulators had no right to oversee national banks in any meaningful way. According to Eliot Spitzer, then the attorney general of New York:

“The OCC today issued two regulations designed to protect national banks at the expense of consumers.

“One regulation would broadly preempt all state laws against national banks, including predatory lending laws, leaving only narrow exceptions for contracts, debt collection, acquisition and transfer of property, taxation, criminal, zoning and tort laws.

“The other regulation would confer upon the OCC exclusive jurisdiction over national banks, and specifically exclude state attorneys general from enforcing consumer protection laws against national banks.

“Together, the two regulations would prevent the states from enacting or enforcing almost any law against national banks, including consumer protection laws of general applicability that apply to every other business in the state.

“These regulations would also result in an unprecedented expansion of the OCC’s powers, while at the same time shielding the banks from state enforcement officials charged with protecting their citizens from fraudulent and illegal conduct.

“The OCC regulations are opposed by a bi-partisan coalition of state officials. In fact, all 50 state attorneys general have submitted comments to the OCC opposing this action. The attorneys general have noted that OCC devotes the vast majority of its time and resources to monitoring the safety and soundness of financial institutions, and does not have the states’ experience, expertise, resources or record in addressing consumer protection issues.”

Spitzer was exactly right.

The truth is that the mortgage meltdown was entirely preventable. The Federal Reserve, under the Home Ownership and Equity Protection Act, has the unilateral right to ban mortgages and mortgage activities which it defines as “unfair and deceptive acts or practices.” Under the chairmanship of Alan Greenspan — a long-time Rand devotee — the Fed never used its power to stop option ARMs, interest-only mortgages or no-doc loan applications.

Think about it:

If the mortgages were good then the mortgage-backed securities (MBS) would be good. If the mortgage-backed securities were good then the banks and brokerages would not have massive losses, mortgage investors would be whole, the companies that “enhanced” (insured) mortgage-backed securities would be profitable, and people across the country would not be losing their homes because they financed with “nontraditional” loan products that included surprise terms, prepayment penalties and huge monthly cost increases. And if the housing sector was okay then home prices might well be stable and many of the job losses we have today would never have happened.

There’s little doubt that many will discount the marches and tweets now growing in volume and fervor. That’s a mistake. In the same way that the Vietnam war became unsustainable as political support waned, that’s now happening with the policies, tax breaks and favors for big banks, big brokerages and big corporations. It’s our new financial Vietnam and like the first one it has cost great treasure, weakened our economy, hurt our national interests and devastated the social contract.

“There’s class warfare, all right,” Warren Buffett told the New York Times, “but it’s my class, the rich class, that’s making war, and we’re winning.”

I disagree. It’s not the “rich” it’s the greedy. There are a lot of rich people — including Buffett, Bill Gates and even JPMorgan Chase CEO Jamie Dimon — who understand that higher taxes are a cheap price to pay for social consensus.

It’s also in a large sense not a left-versus-right or conservative-versus-liberal debate. Rather there’s a growing understanding that Albert Einstein was right when he said “the thinking it took to get us into this mess is not the same thinking that is going to get us out of it.”

Moreover, it’s hard to see that there are many winners. If you don’t believe it just look at the Bank of America — it’s downsizing and planning to lay-off 30,000 workers.

There is an answer. Big financial institutions need to be smaller so there’s less risk to us all. Repeal the Gramm-Leach-Bliley Financial Services Modernization Act and bring back Glass-Steagall, a 1933 law which said that a bank could make loans and collect deposits or it could raise money and sell securities — but not both. Require financial institutions to have a 5 percent cash reserve for every derivative they buy, sell, finance or insure — for themselves, for others or for a subsidiary. Limit the size of depository institutions to $100 billion in assets. Limit the size of branch networks to a maximum of ten states. Prohibit commercial banks from selling insurance or annuities. Limit ATM charges to $1. Allow state bank regulators to define predatory loans and enforce their definitions even when national banks, thrifts and credit unions are involved.

The list goes on but the point is obvious: A financial institution which can undermine the entire economy of the United States is not just too big to fail, it’s also too big to regulate and too big to exist.

Financial holding companies can divest divisions and subsidiaries until they’re rightsized, downsized, focused, leaner, more efficient and more profitable; a better deal for customers, clients, employees and shareholders. The businesses that are sold off can keep their employees and function independently — and sink or swim on their own without needing or expecting a taxpayer bailout.

America’s Big Banks, America’s Financial Vietnam is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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It’s also nothing new. We’ve been reporting about problems with the foreclosure system for years. We gave a 2006 speech before the nation’s real estate regulators at the height of the real estate boom explaining why huge numbers of foreclosures were inevitable. (See: Toxic Loans: The Storm To Come)

On September 20th Bloomberg News reported that “Ally Financial Inc.’s GMAC Mortgage unit told brokers and agents to halt foreclosures on homeowners in 23 states including Florida, Connecticut and New York.” (See: Ally’s GMAC Mortgage Halts Home Evictions in 23 States)

In turn, Ally denied the story, saying that “recent reports have stated that GMAC Mortgage instituted a moratorium on all residential foreclosures in 23 states. This is not true. In fact, all new residential foreclosures are continuing in the ordinary course of business with no interruption in our usual practice.

“The speculation likely emanates,” said Ally, “from a direction previously given by GMAC Mortgage to certain of its outsource vendors to allow time to address a potential issue that was raised in a number of existing foreclosures challenging the internal procedure we used for executing one or more judicially required forms. This direction was to suspend evictions and REO closings where the related foreclosure could have been impacted by the same internal procedure. We are also reviewing certain previously completed foreclosures where the same procedure may have been used.”

The Washington Post then chimed in with two important stories:

First, on September 22nd, the Post reported that “some of the nation’s largest mortgage companies used a single document processor who said he signed off on foreclosures without having read the paperwork — an admission that may open the door for homeowners across the country to challenge foreclosure proceedings.”

The problem is that lenders are supposed to have an official review all paperwork to assure it’s correct and accurate before seeking a foreclosure. In the case of Ally, reported the Post, the “head of Ally’s foreclosure document processing team, 41-year-old Jeffrey Stephan was required to review cases to make sure the proceedings were legally justified and the information was accurate. He was also required to sign the documents in the presence of a notary.

“In a sworn deposition, he testified that he did neither.”

“The reason,” says the Post, “may be the sheer volume of the documents he had to hand-sign: 10,000 a month. (See: Ally Financial legal issue with foreclosures may affect other mortgage companies)

The next day, the 23rd, the Post gets to the heart of a central foreclosure issue:

“The nation’s overburdened foreclosure system is riddled with faked documents, forged signatures and lenders who take shortcuts reviewing borrower’s files, according to court documents and interviews with attorneys, housing advocates and company officials.”

The Post then explains that “during the housing boom, millions of homeowners got easy access to mortgages while providing virtually no proof of their income or background. Now, as millions of Americans are being pushed out of the homes they can no longer afford, the foreclosure process is producing far more paperwork than anyone can read and making it vulnerable to fraud.” (See: Amid mountain of paperwork, shortcuts and forgeries mar foreclosure process)

The Post headline is simply wrong. Shortcuts and forgeries don’t just “mar” the foreclosure process, they damage the legal system, cripple the courts and undermine public trust. Everyone deserves not only their day in court but also the expectation of fairness when they arrive, and that includes families facing foreclosure.

Not “Just” A Paperwork Problem

The fact that borrowers obtained financing with no doc or low doc loan applications has nothing to do with a foreclosure proceeding. Lenders created the mortgage programs which allowed such applications and literally wrote the loan documents — they’re composed by lots of lawyers “in the lender’s usual form,” an expression which means the lender writes the loan rules and requirements.

When lenders foreclose they have an obligation to meet all requirements. If lenders do not correctly process their own claims that’s not the fault of the borrower.

A foreclosure is not a minor matter. Courts have an obligation to assure that the loss of a home — literally tossing someone on the street with everything they own — is justified. If that means a slow process, so be it. If that means all requirements to foreclose must be met, then that’s what should happen.

Money

The looming problem for lenders — and for courts — has been the wholesale denial of borrower rights. This is not merely a problem with “paperwork” or a “technicality.” The court system has been unjustly used to throw people out of their homes. How much of a bigger issue could there be?

One inevitable by-product of the mortgage lawsuits which are sure to come will be instances where foreclosures are determined to have been unjustified. One has to ask: How do we compensate borrowers who have lost their homes and been humiliated? How much money represents “just” compensation? Is there enough lender money to pay such claims?

Can We Undo Botched Mortgage Foreclosures? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: courts, Foreclosures, forgeries, fraud, interest-only, loan, low doc, mortgage, no doc, option ARM, paperwork, shortcuts, technicality, toxic

Under the Home Ownership Equity Protection Act (HOEPA), the Fed has the power to fight “unfair and deceptive acts or practices” or, as they’re called, UDAP. In fact, the Fed has had such power since 1994 and therein lies the rub.

The purpose of financial regulation is to create something of a level playing field. In real estate, for example, you can’t have a “net” listing. Yes, such listings could produce big profits for brokers, but state regulators across the country have banned such arrangements because of their obvious potential for abuse.

Federal regulators, in contrast, have traditionally taken a cautious approach to lenders but in the past few years they left the financial marketplace untouched and the result has been obvious: You didn’t have option ARMs or the widespread use of stated-income loan applications in the past because previous administrations telegraphed their positions to lenders: You can go so far, but no further.

Until the second Bush Administration the deal with the lending community was this: You can make profits, big profits, but use some care and caution otherwise we’ll be forced to create a bunch of regulations that will reduce your revenues. In other words, a gentleman’s agreement of sorts, an unspoken arrangement that worked fairly well for everyone.

The Bush Administration has a different view. It is not a “conservative” perspective — remember, no lender issued option ARMs when Ronald Reagan was in office — instead, with Mr. Bush we have a radical and absolutist political philosophy which argues that unfettered markets are the sure solution to all problems.

Under the Bush approach if a lender makes dim-witted loans and doesn’t bother to effectively underwrite mortgage applications the marketplace will respond. There’s no need for government action because in time loans will fail and shareholders will lose money.

The Bush regulatory theory may be worth debating in some seminar regarding abstract political philosophies, but in the real world we are each inter-connected. If large numbers of lenders make large numbers of foolish loans, it’s not only shareholders who suffer, it’s the value of our house that falls when neighbors are foreclosed.

Given the radical and extreme thinking of the past few years, we are now seeing radical and extreme responses. To right the financial ship of state — if that is possible without further dislocations — the federal government has now embarked on an economic path normally associated with third-world countries. For instance:

• The federal government over the summer of 2008 quickly and with little debate established the right to buy Fannie Mae and Freddie Mac. If this were being done by governments in Malawi, Cuba, Venezuela or Rumania, we would be talking about “nationalization” and all that the term implies.
• The Securities and Exchange Commission over the summer applied special rules to prevent short-selling — but only for 19 favored companies. In effect, we replaced the free-market system with two classes of corporations, those protected from short-sellers and those which are not.

• The Federal Reserve has made hundreds of billions of dollars in friendly loans available to selected banks and private entities on Wall Street. These loans are secured by assets of dubious quality — if the quality were so good then surely such assets could just be sold on the open marketplace. Meanwhile, legislation to help 400,000 borrowers with toxic loans was stalled for months because of alleged worries that the cost might total $4 billion.

The tragedy here, the disgrace here, is that none of this was necessary.

Go back to the new Federal Reserve rules introduced over the summer of 2008. They are weak and timid; most “protections” only apply to “high-priced” loans, meaning not prime or ALT-A financing.

But imagine if the new standards had been instituted in 2002 and 2003: For instance, the new rules say that lenders must “verify the income and assets they rely upon to determine repayment ability” when making “high-priced” loans. In other words, stated-income loan applications are out for subprime borrowers. Would there be a subprime crisis today if such baseline standards had been introduced when they were actually needed?

What makes no sense is the lack of anger. If Canadian trade regulations caused $500 billion or a trillion dollars worth of damage to the U.S., the entire country would be irate. But if a few federal bureaucrats, zealots and elected officials produce the same result, no one seems especially distressed — and that should worry us all.

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Published originally by The Real Estate Professional and posted with permission.

Mortgages & The Unnecessary Crisis is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: application, ARM, deceptive, HOEPA, Home Ownership and Equity Protection Act, income, interest-only, Mortgages, option, stated, UDAP, unfair

As someone now in the process of selling, I am elated by current market conditions: As long as the check clears I heartily approve of interest-only loans; I believe the availability of 100-percent financing is a Constitutional right and if lenders are content with drive-by appraisals it’s okay by me — even if the investment property I’m selling is barely visible from the road.

But I’m not a seller every day. When the property settles I will be a buyer and my view will quickly change. And regardless of which side of the transaction one is on, financial sanity on a national level is important to us all.

All of which brings us to Alan Greenspan, the chairman of the Federal Reserve. Despite all the yammering and mooing about a national real estate bubble, Greenspan has finally explained what readers of this column have long heard: There is no national real estate market. There are many local markets. A nationwide drop in average prices would have a modest economic impact in most areas and no impact at all for many owners.

“Although a ‘bubble’ in home prices for the nation as a whole does not appear likely,” says the Fed chairman, “there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels.”

“The housing market in the United States is quite heterogeneous, and it does not have the capacity to move excesses easily from one area to another. Instead, we have a collection of only loosely connected local markets. Thus, while investors can arbitrage the price of a commodity such as aluminum between Portland, Maine, and Portland, Oregon, they cannot do that with home prices because they cannot move the houses. As a consequence, unlike the behavior of commodity prices, which varies little from place to place, the behavior of home prices varies widely across the nation.”

In other words, as has been said here repeatedly, real estate is a localized commodity. Looking at national trends does not tell us what’s happening down the street or across town.

One of the realities which dampens real estate speculation is that homes actually have a “use” value, it’s a place to live in or rent. If you own a house and local price trends moderate or even fall, it’s not great news but the practical impact may be zero, especially if you have a fixed-rate loan and no urge to sell.

So why do we talk about the national real estate market? Because it’s an easy benchmark to watch. What we really need to talk about are sales in the neighborhood and sales in a ZIP code.

“Speculation in homes is largely local,” says Greenspan, “especially for owner-occupied residences. For homeowners to realize accumulated capital gains on a residence — a precondition of a speculative market –they must move.”

There is a different market for mortgage financing, however. That market is nationwide and growing numbers of high-risk loans should make us all nervous.

It is here that my thoughts as a seller differ from my thoughts as a citizen. Yes, I am elated to sell property to anyone with a check of the proper size, but I wonder why lenders make such risky loans and whether the economy is well-served by such financing.

“The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other relatively exotic forms of adjustable-rate mortgages, are developments of particular concern,” according to Greenspan. “To be sure, these financing vehicles have their appropriate uses. But to the extent that some households may be employing these instruments to purchase a home that would otherwise be unaffordable, their use is beginning to add to the pressures in the marketplace.”

Lastly, in an oblique way, Greenspan touched on the matter of real estate commissions.

It is routinely said that real estate commissions should fall because commissions have dropped for stock brokers, travel agents and such. However, the electrons required to sell 100 shares at $2 each are no different than the impulses needed to sell 100,000 shares at $20 each — in both cases we merely have a few electronic blips moving from here to there.

But homes are not interchangeable — economic theory holds that real estate is a “nonhomogeneic” commodity — a fancy word meaning all properties are unique.

Greenspan says “because of the degree of customization of homes, it is difficult to achieve significant productivity gains in residential building despite the ongoing technological advances in other areas of our economy. As a result, productivity gains in residential construction have lagged behind the average productivity increases in the United States for many decades. This shortfall has been one of the reasons that house prices have consistently outpaced the general price level for many decades.”

Uniqueness, of course, is why no one buys a home over the phone, sight unseen. It’s also the reason local brokers who physically exist in your ZIP code consistently have value while brokers far away in some distant galaxy are irrelevant.

Greenspan says “although we certainly cannot rule out home price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications.”

If Greenspan’s comments had subtitles, they would say In English that even if home prices fall, they won’t fall everywhere and the overall impact is likely to be minimal on a national scale.

That said, do your part. If it requires interest-only financing, a stated-income loan or a 100-percent mortgage to buy property, if you can’t finance the home of your dreams with a fixed-rate loan, look toward the future: Buy small, buy less, save more and stop racking up credit card debt. You’ll be grateful if and when interest rates rise and home sales moderate on your street.

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Published originally by Realty Times on June 14, 2005 and posted with permission.

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

Technorati Tags: caution, Greenspan, interest, interest-only, mortgage, only, rates

An interest-only loan is both what it seems and not what it seems. It’s interest-only debt for some or all of the loan term, but it’s also likely to be a form of “balloon” financing — a loan with a huge final payment, often as large as the original loan balance.

To see why, let’s compare a sample interest-only loan and a basic fixed-rate mortgage.

Imagine that we borrow $200,000 at 3.8 percent — that’s the six-month LIBOR index (2.3007 percent) when this posting was originally written plus a 1.5 percent margin. This is an adjustable-rate mortgage (ARM) where the rate can rise or fall. In the case of this mortgage, the initial rate is fixed for 10 years and the loan is an interest-only product during its first decade. After the first 10 years, the interest rate adjusts for the remaining 15 years.

For purposes of example, let’s also agree that the interest rate will not change after 10 years and that no points are being charged. Let’s also create a mythical 25-year fixed-rate loan at 3.8 percent. Here’s how the loans stack up.

In terms of monthly payments, the interest-only product costs $633.33 a month during the first decade while the fixed-rate loan with a 25-year term has a monthly cost of $1,033.71.

At the end of 10 years, the interest-only borrower has paid out $76,000 while the fixed-rate loan has cost the borrower $124,045 — a difference of $48,045.

The money paid out, however, is not the only issue to consider. At the end of 10 years the interest-only borrower still owes $200,000 while the fixed-rate loan balance has been reduced to $141,661.69. That means $58,338.31 has been knocked off the loan amount versus nothing from the interest-only loan.

If we compare the monthly cash saved in the first 10 years by the interest-only borrower ($48,045) with the principal reduction earned by the fixed-rate borrower ($58,338) we can see that the interest-only approach is actually more costly by $10,293.

In our example we have two 25-year loans. In the first 10 years rates and costs for both loan products do not change. However, for the remaining 15 years the fixed rate borrower will continue to pay out $1,033.71 per month while the story for the interest-only borrower is very different.

After 10 years the interest-only borrower still owes $200,000, a debt which must be paid out over the remaining 15 years of the loan term. At 3.8 percent the cost per month for principal and interest will be $1,459.41.

Over the 25 year term, the fixed-rate loan will have a total interest cost of $110,114. The interest-only loan? There was an interest cost of $76,000 during the first 10 years and an interest expense of $62,694 in the last 15 years, a total of $138,694. In effect, the premium for interest-only financing is $28,580 — a huge difference even if the interest-only rate remains unchanged during the life of the loan.

This analysis raises some questions:

Do most people have a loan for 25 or 30 years?

No. But when an interest-only loan is paid off during the first 10 years, the most-likely scenario, the entire debt remains outstanding. That means that compared with an amortizing loan there are fewer dollars from closing which can be invested in a replacement property or used for other purposes.

Why consider a 25-year fixed-rate loan when most people use 30-year financing?

For purposes of example only. With a 30-year term, a $200,000 fixed-rate loan at 3.8 percent interest — if there were such a thing — would have a monthly cost for principal and interest of $931.91. If the fixed-rate loan was paid off over 30 years the total interest cost would be $135,489.29.

Is interest-only financing a good choice for people with limited incomes?

If their income continues to be “limited” when the interest-only loan switches into phase two, the amortization years, the borrowers may be in trouble because of higher monthly loan costs. If a borrower has a good and growing income then the matter of higher monthly costs need not be a problem.

The example uses the same rate of interest for 25 years with the interest-only mortgage. Do you believe that interest rates will be essentially unchanged from today’s rates for the next 25 years?

I believe it’s more likely that web-footed fern people from the planet Norkvar VII will land in Iowa.

What happens if the interest-rate rises after 10 years?

In our example with a $200,000 loan, the monthly payment would increase from $633.33 to $1,479 (4 percent), $1,582 (5 percent), $1,688 (6 percent), $1,798 (7 percent), $1,911 (8 percent) and $2,029 (9 percent). If the loan has a 6-percent lifetime interest cap above the start rate (3.8 percent) then the highest monthly cost in the last 15 years of the loan would be $2,125. In all cases, of course, property taxes and insurance are extra.

Why not just refinance with a new, fixed-rate 30-year loan after five years?

This is possible, assuming that the property has sufficient value and that the borrowers can qualify for a new loan. However, since the principal balance has not declined, refinancing $200,000 after five years means that you effectively have a 35-year mortgage — a loan with much higher overall interests costs plus the expense of an additional closing. A $200,000 mortgage financed over 35 years at 3.8 percent has a potential interest cost of $161,921.32.

Converting to a 15- or 20-year loan might make more sense in terms of potential interest costs, however monthly payments will be higher than with 25- or 30-year financing.

Why not just re-sell the property as home prices increase?

First, home prices do not always increase. Second, if home prices do increase and a property is sold, the owners must move elsewhere. Will a replacement home be less expensive than the one which was sold?

Why worry about future monthly costs? With inflation we’ll be paying with cheaper dollars.

The value loss from inflation will be offset or exceeded by rising interest levels. If you want to benefit from cheaper dollars in the future, get a fixed-rate loan at the lowest possible interest rate and let the lender worry about inflation.

I hear advertisements saying that I can save hundreds of dollars each month with interest-only financing. Isn’t this true?

Here’s what’s true: With an interest-only loan your initial monthly cash payments each month will be — and be sure to read the rest of this paragraph — lower than with a self-amortizing loan of the same size and with the same rate and terms. However, the interest-only borrower has more debt for a longer period and thus higher total costs. And if rates rise, monthly costs and overall interest costs could be substantially larger than with fixed-rate financing. One way or another, Miller’s first law of financing holds true: The lender always collects.

Can you think of any cases where an interest-only loan might be attractive?

Yes. In a situation where (1) the value of real estate is reasonably expected to rise at or above the rate of inflation because local population growth is outstripping new home construction and the local job base is growing; (2) the borrowers have rising incomes; and (3) the borrowers faithfully prepay each month during the initial 10-year period to reduce future risk.

With prepayments allowed in whole or in part and without penalty, disciplined borrowers with good incomes and appreciating properties can effectively convert interest-only financing into ARMs with lengthy and cheap start rates. By making pre-payments and reducing the loan balance during the initial fixed-rate period, borrowers will owe less when the loan converts to ARM status or is refinanced. With less principal outstanding, the borrowers will have less interest than if the loan had remained at its original size.

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Published originally by Realty Times on November 30, 2004 and posted with permission.

The Beauty of Interest-Only Loans — And The Beast is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: dangers, interest, interest-only, loan, mortgage, only

Term — or “straight” financing — pretty much came to an end in the 1930s because as homes and farms lost value during the Great Depression, loans could neither be paid off nor renewed. One result was the movement pioneered by the FHA toward long-term, self-amortizing mortgages which offered more security to borrowers during hard times.

Today self-amortizing loans, mortgages in which the entire principal is paid off during the loan term, are a given — but term loans are making a comeback. We don’t call them “term” mortgages, but in a practical sense that’s probably the best way to view today’s new crop of interest-only loans.

Around the country we have seen enormous increases in home values in the past decade. If you own real estate for five years or more the odds are overwhelming that you have an appreciating asset, one which simply reflects the growing imbalance between supply and demand seen in many communities.

Alternatively, 40 percent of all existing homes are bought by first-time buyers, people who tend not to be at their peak earning years or to have accumulated much in the way of savings. By definition, of course, they have no real estate equity to invest in a residence.

Interest-only loans address this issue by lowering monthly cash costs for borrowers. With an interest-only loan at $993 a month and 6.25 percent interest, it’s now possible to borrow $190,656. With 10 percent down, homes in the $212,000 range are suddenly approachable — homes which may be better located, bigger or with more amenities than less expensive offerings.

Since the interest is likely to be entirely deductible and the initial monthly cash cost is lower than with amortized debt, it’s easy to see how buyers can be attracted to such financing. No less important, many borrowers justify such loans on the grounds that only monthly payments count, not total debt. An interest-only loan is somewhat like “rent” in this view, only with the possibility for appreciation and better tax write-offs.

The catch is that interest-only loans are not without risk.

Such financing, for example, is often based on a fixed-rate, interest-only payment for five years after which the loan becomes a one-year ARM for the balance of the term. If the loan is then amortized, it must be amortized over 25 years, not 30 years. If future rates hit 7 percent, here’s what happens: Monthly payments for principal and interest after five years go from $993 to $1,497. At 8 percent, the new monthly P&I will be $1,635.

Will higher monthly costs be a problem down the road? Probably not for most borrowers — just think of what most borrowers earned five years ago. But what if incomes don’t rise or don’t rise much?

An alternative option is selling after five years or so — if home values rise sufficiently.

Can past home price movements guarantee future trends? No — there’s always risk in the marketplace.

I’ve recently heard that borrowers will “save” money each month with interest-only loans, an imprecise expression which may raise concerns with regulators.

Interest-only loans reduce monthly payment costs when compared with fixed-rate financing, however to say these lower costs are a “savings” is debatable. Why? An interest-only loan and a fixed-rate mortgage are different loan products. The term “savings” implies a benefit which isn’t there: The cost of the loan is not lower, instead borrowers are paying less per month because they have elected not to reduce the principal balance for some or all of the loan term.

There’s demand for interest-only loans, there are logical and reasonable arguments to be made for and against such financing, but in the end they’re merely loans past generations have seen before — and sought to avoid.

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Published originally by Realty Times on August 10, 2004 and posted with permission.

Should We Return To Straight Mortgages? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: avoid, FHA, interest, interest-only, mortgage, only, real estate, risk

From the borrower’s perspective, it’s important to know how long the teaser rate will last (longer is better), and whether it is a fully-amortizing rate — that is, whether all interest is being paid during the teaser-rate period. If not, look out — you can expect steeper monthly payments when the teaser period ends and a much harder time selling the house because the mortgage balance will have grown.

Loans such as option-ARMs, interest-only mortgages, 2/28 and 3/27 mortgages are associated with low up-front costs — and steep foreclosure levels.

What’s a mortgage “teaser” rate? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

Technorati Tags: interest-only, low-ball, mortgage, option ARM, rate, starter, teaser

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

Technorati Tags: ARELLO, Association, disclosure, income, interest-only, Law, License, loans, Mortgages, Officials, stated, toxic

I always tell folks there is no shortage of either lenders or loans, the real question concerns borrower preferences. If a borrower is sufficiently “motivated” then there are always loans to be had. Of course, when there is sufficient motivation there are also borrowers to be had, a thought which brings us to the subject of loan-to-value ratios.

This may sound like a real snoozer, but LTV is a subject which may soon haunt lots of people. Across the country there are now incidental reports of falling home prices, especially in the upper brackets. “Price changes” now seem to be more common in listing notices, and by “price changes” no one means sellers are asking more.

If we are seeing a pause in the remarkable series of price increases seen during the past few years, and if in some cases we are seeing actual declines, then the game changes. Millions of people who bought at or near full price may suddenly find that they own a property which is worth no more and perhaps less than what they paid.

This is not really much of a practical concern for those who stay put, but what about those who move? If you paid $500,000 for a home that is now worth $485,000 can you sell?

In this example the price drop is just 3 percent, not a lot in the context of the purchase price but enough to sink two groups of buyers, those who purchased with little down and those who bought with high-risk financing.

Over the years the amount down required to buy a home has fallen dramatically. If you were a buyer in the 1970s your financing choices were largely limited to conventional loans with 20 percent down, FHA mortgages with 5 percent down and VA financing with nothing down.

Today downpayment requirements are non-existent. You can buy with nothing down and you can even buy with 110 or 125 LTV loans — in other words, you can borrow more than the house is worth, enough to finance both the purchase and closing costs — plus maybe something extra.

Loony loans with little or nothing down are a philosophical worry when home prices are rising — and a real disaster when property values are stagnant or falling.

Go back to that $500,000 home, the one now worth $485,000. Guess what? It’s can’t be sold for $485,000, at least not in the sense of getting a check for that amount at closing.

Sell a property for $485,000 and you have a starting point from which to deduct taxes, marketing expenses and settlement expenses. You may wind up with $460,000 or maybe less.

The difference between a $500,000 debt — the sale price of our model property purchased with nothing down — and a $460,000 net selling value is minus $40,000. Do sellers have such money? Some do — but many who bought with nothing down or extra-jumbo loans cannot bring such cash to closing. And that $500,000 purchase price does not include settlement costs to buy, perhaps another $10,000 or $12,000.

In some jurisdictions the ability of lenders to recover purchase-money loan losses is limited to the value of the property. In effect, the seller cannot be sued by the lender for a loss on the mortgage when the property is sold. However, such protection does not exist in most states, does not apply to properties which have been refinanced and does not apply to home equity loans.

In effect, many who bought at the top of the market with little or nothing down cannot sell because if they sell they will be bankrupt even if home prices fall just a touch. The good news, in a sense, is that by not selling such folks hold down supply and thus keep prices up.

But the other problem is that many who have purchased with no money down, with interest-only financing, with stated-income (no-tell) loans, with adjustable-rate mortgages and with option payment financing also cannot stay.

Many loans today allow buyers to acquire homes with small monthly payments — at least at first. But the point comes when those microscopic up-front payments soon require full-blown monthly remittances.

A recent letter said I could borrow $500,000 and pay just $1,608 per month. That’s $19,296 a year in loan costs, a payment rate equal to 3.8 percent — at least at first.

However, rate caps may result in “deferred” interest. In other words, that initial monthly payment may not be the amount actually needed to reduce the debt. If the real interest rate is 4.7 percent, then the required interest-only payment would be $1,958 per month. With interest-only payments the loan is not getting any smaller, but at least it’s not getting any bigger.

You might think the loan with the low payment rate would save the borrower $350 a month ($1,958 less $1,608). However, if the missing interest payment is added to the loan balance, and if interest rates do not change, then at the end of five years another $21,000 in monthly shortfalls would have been added to the loan. Of course, interest rates might rise and each monthly addition to the principal balance would also increase the interest cost.

In general, let’s say that after five years the debt is now $521,000 and that the interest rate increases to 6 percent — a minimal interest level for most of the past 50 years. The loan now has 25 years remaining and the monthly payment will be $3,356.80 for principal and interest. That’s more than twice $1,608.

The prevailing theory seems to be that higher monthly costs are not a problem because one can just sell the underlying property. But such thinking assumes that property values will rise — and that is not guaranteed. If property values merely stay the same large numbers of people in the next few years will be both unable to make monthly payments and unable to sell for enough to pay off growing mortgage debt.
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Published originally by Realty Times on November 1, 2005 and posted with permission.

Real Estate Exit Strategy: What If There’s No Way Out? is a post from: OurBroker.com -- Refinance, Home Mortgage Loans & Rates, Home Equity Loan

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