Are modest-income, minority and credit-challenged home buyers being targeted for the new breed of "non-traditional" mortgages -- interest-only and "payment option" plans -- that allow purchasers to stretch their incomes and buy higher cost properties?
That's a key question not only for consumers but for the realty agents and home builders who work with them as well. Non-traditional loans may help get consumers into houses they might not otherwise be able to afford, but they could also lead to higher delinquency and foreclosure problems down the road when payments "re-set" to fully-indexed levels. Some non-traditional programs carry reset terms that result in monthly payment increases of 80 to 100 percent higher than the introductory period payment levels -- virtually guaranteed to induce "payment shock" for borrowers who have inadequate incomes or credit situations.
Payment-option and interest-only loans have become wildly popular during the past 18 months, especially in markets where housing prices are high and appreciation rates have been in the double digits. In markets like southern California and Washington D.C., non-traditional loans accounted for 40 to 50 percent of total new mortgage originations last year.
But now a new national study argues that too many of these non-traditional financing plans are being targeted to home buyers who may be ill-prepared to handle future higher payments. The study was conducted by the Consumer Federation of America (CFA) on a sample of 100,000 mortgages closed by lenders between January and October of 2005.
Among the key findings:
Fair Isaac Corp., developer of the FICO credit score widely used to qualify mortgage applicants, says the average FICO score in the U.S. is around 720.
The interest-only concept began years ago as a tool for high-income borrowers, but now, according to the CFA, it is being mass-marketed to families with incomes below median in some high-cost, high-priced metropolitan markets.
CFA's senior researcher for the study, Patrick Woodall, says the findings should be a red alert to consumers, lenders and financial regulators alike. "Non-traditional mortgages are more complex than your parents' home loan, and some highly-leveraged or unsophisticated consumers could end up learning that the mortgage that helped them buy their home was a ticking time bomb that destroyed their finances for years."
Federal financial regulators are expected shortly to issue new guidelines for lenders nationwide on non-traditional mortgages, with special attention to underwriting quality, and determinations about the "suitability" of such potentially risky loans for the borrowers who apply for them.
