Picking between the various mortgage products is a lot like choosing between butter and margarine, according to the new survey from the Mortgage Bankers Association which confirms the increased popularity of such nontraditional products as interest-only and pay-option loans.
When money is tight, many people switch to the low-price spread. And the same, it turns, goes for home buyers who, when faced with higher mortgages rates, also tend to go with the cheaper alternative.
That used to be the traditional adjustable rate mortgage, a loan in which the rate changes every one, three or five years, depending on market conditions at the time. But now, it's IOs and POs, according to the MBA survey of 110 lenders who are responsible for more than half's the country mortgage production.
The survey found that while ARM originations fell from 46 percent to 36 percent between the last half of 2004 and the first half of 2005, the share of IOs went up from 17 percent to 23 percent.
Like the name implies, interest-only mortgages are loans in which borrowers make interest-only payments for a set period, usually three, five or even 10 years, and than make regular payments over the remaining term. In choosing an IO, many consumers are forgoing a gradual, albeit slow build-up in equity in hopes that home values will continue to appreciate rapidly.
The IO is the affordable loan product du jour, said Doug Duncan, the MBA's chief economist. "It is enjoying overall market acceptance because it offers the lowest payment alternative that gets people into the house they want to buy," he said.
But, while consumers have "always been very good at optimizing their product choices," Duncan warned that they need "to be vigilant to ensure that they prudently measure and manage the additional risk" incumbent with the latest loan offerings.
In the case of IOs, the danger is that prices won't go up as fast as they have been, that they won't go up at all, or, heaven forbid, that they could fall. With any of these scenarios, an owner could find that he's built so little equity in his house that he'll take a loss when it comes to sell.
Interest-only loan originations tend to be greatest in markets where prices are highest, so they "could be problematic" in places where housing prices are out of whack with reality. But overall, Duncan said the new fangled loan does not pose a peril to the housing sector.
Because 35-40 percent of all owners hold their homes free and clear and half the rest have fixed-rate mortgages, only 15 percent or so have any interest-rate sensitivity, he explained. And only half of those are new recent enough owners, so "unseasoned" in mortgage industry parlance that "we don't know how they will act."
The MBA survey, which was released at the group's annual convention in Orlando, also found that while nine out of 10 interest-only loans originated during the first half of 2005 were adjustable rate products, the trend now is toward fixed loans in which the loan amount is amortized over the years after the IO period expires. In other words, with a 10-year IO, total amount borrowed with interest would be paid over the last 20 years.
