March 21st, 2007

Some home loans made over the past few years were designed to allow initial periods of very low payments.  Many of those were “teaser” loans, which called for very low initial interest rates.  A big chunk of the initial low-interest and teaser-rate loans are scheduled to reset to higher rates starting this year.  Some option ARMs, adjustable and interest only loans will call for much larger principal payments when they adjust and get recast. 

Many home borrowers are likely to face the challenge of a large reset while at the same time, fallen property values and little money down will leave many borrowers with no equity, thus making it difficult to refinance.  Many lenders have recently tightened their lending standards, and even though some homeowners were able to qualify for a mortgage one or two years ago, doesn’t mean they’ll qualify for a new loan today.  As an example anyone could qualify for a 100% loan with 580 credit score. Today you need at least 620 FICO score to get a 100% loan on a home, and don’t count on getting 100% from a subprime lender. The defaults in mortgages won’t severely hurt the economy and will account for about 0.36 percent of U.S. Gross Domestic Product.  

The U.S. mortgage industry loans about $2 trillion each year, so the losses from foreclosures may be less than one percent of total lending.  The expected 1 million foreclosures represents about 13 percent of the adjustable-rate mortgages originated from 2004 to 2006, equaling about $326 billion in debt.  The study assumed that after all the foreclosure sales would be completed; about $112 billion would be lost by lenders.  The expected $112 billion in losses won’t break the mortgage industry but will inflict pain on lenders and home borrowers affected by the defaults. 

About 1 million additional home foreclosures are expected over the next six years as adjustable-rate mortgages, which made home buying more affordable to U.S. buyers in recent years, reset to higher payments.  Many homeowners got into the real estate game not knowing what was looming ahead.  Mortgage brokers and real estate agents made hundreds of thousands of dollars in commissions just selling homes that homeowners can no longer afford and loan salesmen did not take the time to educate homeowners on those risky loans. Mortgage brokers enjoyed selling those option ARMs in California. 

Just imagine selling an option ARM on a $500,000 home.  Many of those loans paid 4 points in the back and if they also charged 2 points in the front that makes a $50,000 commission.  NOT BAD!!!  That is a yearly salary for many people. You probably understand what motivates many loan salesmen and real estate agents.  Option ARMs have allowed loan salesmen and real estate agents to earn much bigger commissions as they sold homeowners more expensive homes.

Buy your home with no down payment and get a super low rate with a payment anyone can afford.  It was a wonderful deal nobody could refuse: Refinance your mortgage at an amazing low rate and cut your payments in half.  New home buyers, stretching their finance to afford a home and they didn’t even need to show income documentation, much less a down payment.  The option ARM is by far the riskiest and most complicated home loan product ever created.  There was plenty more going on behind the scenes they didn’t know about, either: that mortgage brokers received incentives and fat commissions to sell option ARMs than other mortgage programs. 

Real estate agents always recommend their friends to do loans and prospective buyers never think about shopping around.   They tend to trust to much and they just focus on a rate.  That is when they are the most vulnerable.  They want to hear a low rate and that is what mortgage brokers will tell them.  But mortgage brokers have many tricks in their hat and at the closing table they are going to find a reason why the rate is higher.  At that time it is too late for home buyers to back up on a deal as they went through all the paperwork, they have given notice to their landlord and they have packed everything in boxes.  The worst as yet to come.  They just accepted a higher rate, it is adjustable, they have a pre-payment penalty and in two years the rate will even be higher.  Even worst houses will depreciate in value.  Lenders tapped an industry of unregulated and greedy loan salesmen to keep the money flowing, even if it meant putting dangerous loans in the hands of people who didn’t understand the features of those toxic mortgages.  Up to 80% of all option ARM borrowers make only the minimum payment each month.  The remaining balance (unpaid interest) gets added to the balance of the mortgage, which is known as negative amortization. 

Education is very important.  Now people realize that real estate doesn’t go up every year.  But with low rates and decent prices on housing, it’s a great opportunity to get into the market.  With over a million foreclosures ahead, there will be over 1 million people and maybe more who will see their credit score negatively impacted because of a foreclosure on their credit file.  Foreclosure stays 12 years on a credit file.  How likely will they be able to purchase a home in the future?  When will they be able to start building and accumulate wealth?  Who should they blame? 

Should they blame themselves, their real estate agent or the loan salesman? Someone made a mistake, so someone should be held accountable.  Many homeowners with risky mortgages may no longer be able to afford the new mortgage payment, which may increase by a few hundred dollars.  

Many loan salesmen all across the country have bombarded our mailboxes with those option ARM loans, which starts with a 1% rate for the first month only.  Those homeowners who have made the minimum payment will soon have to make a much higher mortgage payment.  How much do they know about their loan program?  Do they know those mortgages have adjustable rates?  Do they know the low payment option may not cover all of the interest due?  Do they know choosing the minimum payment option can lead to negative amortization, or deferred interest?  Do homeowners realize the unpaid interest is added to the outstanding loan balance and each year the minimum payment will increase by a previously determined percentage until the borrower is paying the full principal and interest amount?  Do they know these loans are subject to a maximum amount of deferred interest and the loans may need to be recast?  Do they know how much payment will increase in the future?  Who should be blamed? 

Lenders and mortgage brokers should spell out exactly what a would-be borrower’s monthly payment would be under various interest rate scenarios: If the rate does not change, for example, the payment would be this.  If the rate goes up from the initial rate to this rate, the payment would rise to that.  And if any interest is deferred, the payment and outstanding balance would be this.  Explanations should clearly spell out the benefits and risks” of various loan products “in simple, plain English.  Interest-only loans and other extremely treacherous mortgages can result in foreclosure if the borrower does not understand all the features of these loans.

Many homeowners with adjustable rates including 2/28 and option ARMs were told they could refinance after a couple years.  Unfortunately lenders have tightened their lending standards and home value have either stagnated or decreased.  Those homeowners can no longer refinance their home because their credit is not good enough and they have not built equity in their home.  What’s more, pre-payment penalties prevent them from refinancing.  Those homeowners are stuck with their bad loans.  Real estate agents and loan salesmen have the responsibility to teach their clients about the responsibility that comes with Option ARMs and other exotic loans. 

It is their responsibility (among others) to help them understand the options they can offer.  It is especially important to help homeowners understand the recasting feature of an Option ARM and to make a best effort to forecast the possible recasting point.  Lenders have turned to unregulated loan salesmen, who now account for 80% of all mortgage originations.  In 2004 lenders began offering much bigger sales commissions on option ARMs to encourage brokers to push those toxic mortgages.

The problem, of course, is that many brokers care more about commissions than customers.  They use aggressive sales tactics. Unfortunately many retired people who have worked hard all their lives will be victims of those greedy lenders and loan salesmen.  They will lose their home with all the equity in it.  It is much harder for retirees to qualify for a loan as they are on a fixed income.  Other homeowners can’t afford to refinance because of the hefty fees to refinance and others have a pre-payment penalty.  People are paying more and more every month as the interest keeps going up and up and up. 

Their loan salesmen have stopped returning their phone calls.  And with a blemished credit file and a foreclosure on their file (reported for 12 years on a credit report) they won’t be ready to buy another home for a very, very longtime.  At this point, those people are unlikely to retire wealthy.  They may not be able to leave a great legacy to their children.  The consequences are far worse than one can even imagine.  Buying a home is the American dream. This isn’t how the American dream is supposed to play out, so who should we blame?

To Your Success,  

P.S. If you are at all intimidated or unsure about the mortgage process if you don’t understand how to evaluate your options in getting a mortgage loan our 24 key questions will help you feel comfortable that you are making the best decisions. Also if you are in the process of refinancing your home with anyone, CALL ME and I will let you know if you are being offered the best loan option based on market conditions and your financial situation.

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