Q and A on Mortgages
NOW's producer William Brangham talked with Allen Fishbein director of housing and credit policy at the Consumer Federation of America about interest only mortgages and the changing home ownership landscape. Below are edited selections from that interview.
ALLEN FISHBEIN ON INTEREST ONLY MORTAGAGES
Interest only loans are growing, because increasingly borrowers are finding it difficult to afford to buy a home in many markets. And so they're looking to increase their purchasing power and interest only mortgages offer certain features that help them do that at least initially. We're starting to see what started out as a boutique or a special niche product that was useful for certain types of households being sold much more broadly through consumers throughout the market.
Interest only mortgages actually are a little more expensive than other mortgages. They may be a quarter point more to the borrowers. And now of course the borrower's not paying principal for the first set number of years. But after that, they actually have to pay higher payments in the form of the of additional interest payments for the principal they did not pay down during those early years.
So they're getting a short-term gain which is helping them to qualify, but they're gonna pay for it later on. Now, many assume that increasing home prices will bail them out of that situation, and if you look over the past few years, in fact, that's been the case in many markets. But consumers certainly can't anticipate that those kind of conditions will go forward and that the home price increase will be anything like it's been in recent years.
If you have an adjustable rate mortgage that's tied to an interest only mortgage, the prospects for higher monthly payments that can be 50 percent higher than your initial payment or more are very great, are very real and something that consumers need to take account in their financial planning. If somebody has a mortgage that's several hundred thousand, $200,000 or $350,000, if there is a run-up in interest rates and as a result they have to make higher payments and typically adjustable rate mortgages may allow adjustments of one and two percent over the course of a single year, that could result in the households having to pay hundreds of dollars per month more than their adjustable rate mortgage was when it was initially set.
These are specialty mortgages, and they started out being a very small part of the market that was useful for people that had uneven incomes, perhaps sales people who had the discipline to make principal payments, when their income became available, perhaps at a certain point in the year.
They're good for wealthy individuals that are seeking to maximize their cash flow, so they can invest in other things. They're useful for people that are fairly certain they're gonna be in a home for a very short period of time, perhaps, and don't want to put a lot of money toward their mortgage payments.
For the average household, the median income of which is about $43,000, this is probably not a good deal for them. And they should do whatever they can to avoid locking themselves into these riskier types of mortgages.
ALLEN FISHBEIN ON OPTION ADJUSTABLE RATE MORTGAGE - "Pay Option Loans"
The hot new mortgage product in 2005 is the option adjustable rate mortgages. [They] provide a range of payment options, including a minimum payment on which the balance of the loan could actually grow, which is called negative amortization.
These loans are sold to borrowers as giving them maximum flexibility. So if they're a little short one month, they could choose just like they do with their credit card, and just pay the minimum amount, which doesn't really reduce the loan balance, and in fact, increases the loan balance.
The danger, of course, is a home is more than a credit card. It's also a shelter. It's also the place where people live. And so, this is not a long term strategy. I think a lot of borrowers go into these types of mortgages, thinking we'll only use this in rare emergencies. But if it becomes a regular practice for them, they're going to find a debt flow that they just cannot handle.
A lot of these ARMs have been sold initially with rates that are as low as one percent, at least for the first month. But they adjust monthly. And so, the rate can quickly shift up from that, particularly as short term interest rates begin to rise. And these are the indexes that the ARMs are based upon. So I don't see this as being a good prospect for most borrowers out there. It might be useful for certain individuals who have a certain financial need or are planning to be in a home for a very short period of time. But for the vast majority of would be homeowners out there, this is not the option they ought to be turning to.
ALLEN FISHBEIN ON THE CHANGING HOME OWNERSHIP LANDSCAPE
It may be a generational thing, but certainly those of us who are in our 40s or 50s or older can remember that home prices have not consistently increased the way they have in recent years. And in fact, haven't done much more beyond the rate of inflation over longer period of time. We also know that interest rates have been considerably higher than they are now, in the double digits in some cases. And so what it costs to finance a house could increase considerably.
The traditional formula that was then about is that no more than 25 percent of your income should be towards mortgage payments, and a third of your overall outstanding income devoted to long-term debt. Now, that's changed.
People are much more highly leveraged than ever before. They're putting down less towards their mortgage, and they're certainly borrowing more. And that's a major change from the way things occurred before. But as long as home prices are increasing, even loans that were at the margins and perhaps should not be underwritten still look okay, because the individual's home is worth so much more one and two and three years down the line. Should that type of double-digit increase not continue, however, people will be then looking at the individual's ability to handle that payment. And if they can't, their alternatives are much fewer than they were before.