For These Mortgages, Downside Comes Later
Wall Street Journal
October 5, 2004
This article in the Wall Street Journal deals with a new type of mortgage for a
borrower that is becoming more popular. These so called interest-rate only mortgages
differ from standard mortgages from the fact that no principle has to be paid initially.
Borrowers usually only pay the interest on the loan for the first 10 years, or in some cases
5. After the period of 5 or 10 years the borrower will then start paying off the principle
and still pay the interest payments. Because the borrower isn’t paying the principle to
begin with the lender can usually charge a higher rate then that of a standard mortgage. It
is usually around 1/8% increase in the interest rate rate. On a $200,000 home the added
1/8% would cause an increase in payment of $250 per month.
What used to rarities and only for wealthy investors, who used them for tax
purposes or investment purposes, are now becoming more mainstream for the average
person wanting to buy a home. There is even a greater increase of these loans where
prices have increases because people are trying to get house they can’t afford or ones
where they think the price will continue to increase. These types of mortgages account
for 10-15% of all mortgages in 2004, up from just 2% a few years ago. J.P. Morgan’s
Chase Home Finance unit represents about 10% of these mortgages this year, four times
that of last year.
With new popularity there is concern that that borrowers will run into financial
trouble when the principle payments begin. However, with no pas experience with
interest-rate only mortgages there is no data on the default rate of borrowers for this type.
Doug Duncan, economist at the Mortgage Bankers Association says “we’re flying blind.”
Now that lenders are beginning to make loans to people with less-than-stellar credit
ratings the default risk may increase.
Lenders are advertising these loans by saying they have low initial payments and
can save the borrower money. However they don’t talk about the downside. Some
lenders argue that they can’t predict the borrower’s financial status in 5 or 10 years so
they don’t take it into account when giving a loan.
Fannie Mea and Freddie have become wary of buying these types of mortgages.
Fannie Mae Vice-President says they don’t like the added risk of theses types of
mortgages. He also says that lenders and brokers are looking to maintain volume in the
market so they sell the loans to people who can’t afford the homes. In the end there is no
long-term experience with theses loans so whether or not it hurts the market or the
consumer will be seen soon.