Interest only mortgages
This is even crazier than adjustable-rate mortgages (discussed previously here and here): in southwest Florida interest-only loans (in which the holder only pays interest, no principal for a certain amount of time) constitute up to 75% of mortgates being taken out right now. The article says that these loans work for these reasons:
- Most interest-only mortgages are going to investors, who are speculating in the local real estate market
- Homes in that market are appreciating rapidly
- The average life expectancy of a loan in the area is currently 2-3 years
So, basically it's a speculator's market--a housing bubble. As long as everything stays the same, it will work, but as soon as any one factor changes, the whole house of cards is likely to come down.
More about adjustable rate mortgages
My previous entry was an attempt to understand why people are taking adjustable rate mortgages in the current realtively low-interest-rate climate. Well, a wire story out today confirms my conclusions--both about the reasons for people taking out ARMs and the their dangers:
Some 36.6% of mortgages, including refinancings and new purchases, had adjustable rates last week, the Mortgage Bankers Association said Wednesday. That's up more than 3 percentage points from the prior week and 9 percentage points from a year ago
With the average rate on a one-year, adjustable-rate mortgage at 4.39% and housing prices continuing to rise in many areas, buyers seeking to keep payments low are opting for ARMs. But some economists warn that homeowners might run into trouble if interest rates are higher and their payments rise when their fixed-rate period ends, typically in one to seven years.
That could also cause problems for the economy if consumers, whose spending accounts for more than two-thirds of U.S. economic activity, are forced to pinch pennies to pay mortgages, or to default.
"While ARMs buy home buyers some relief in housing affordability in the short run, the longer-run implications ... can be negative," says Celia Chen, director of housing economics at Economy.com.
Adjustable rate mortgages
A while back, I was reading about the supposed housing bubble when something caught my eye: if interest rates start to go up significantly, people with variable rate mortgages might be in trouble, as their mortgage payments would increase.
I thought to myself: with interest rates as low as they have been the last couple of years, who has a variable rate mortgage? As I understand it, when interest rates are low, you should get a fixed rate mortgage, so you can lock in a low interest rate for the long term. If interest rates rise, you've got a good deal. Conversely, the only time you should get a variable rate mortgage is when rates are high. You wouldn't want to lock yourself into a high rate (with a high fixed rate mortgage) if interest rates start to fall.
So, I did a little research. It seems that a lot of people are getting fixed rate mortgages in order to get VERY low payments at least for a few years. As this article explains, many mortgages offer a very low fixed rate for five years, then they go variable after that.
Who would want such a loan? Someone who has a shorter-term view than I have. Apparently, lenders are using these types of loans to help people buy more expensive homes than they could necessarily afford with a fixed-rate mortgage.
When considering such a loan, the article says you should ask the following questions:
- What is the interest rate caps on the loan?
- How much can the rate rise when it adjusts the first time?
- How much could it rise over the life of the loan?
- How much would your monthly payments be at the highest rate?
If you don't think your income will increase or if you think you'll be in your home for longer than 15 years, you may not be a great candidate for these types of loans.
I just wonder how many people really think too much about whether they can afford such a loan in the longer term. If they don't, then they are the people who might get into trouble when mortgage rates rise.
'Stated income' mortgage loans
If you don't believe that your credit score is all that matters, check out this article on stated income mortgage loans:
For people whose credit is good enough, "stated income" loans work much like this. Consumers pay slightly higher interest rates for such loans, but bankers are making more of them than ever.
At the end of the refinancing boom in late 2003, lenders started looking for new ways to boost business, and stated income mortgages, and related "low documentation" loans, were one solution. Lenders learned over the past decade or so that credit scores are the best predictors of whether a borrower will pay back a loan, so stated income loans are not as risky as they might sound.
I'm not sure why you even have to tell the lender an income, because basically, they'll give you a mortgage based solely on your credit score (FICO score). Seems like kind of a contradiction to me: your credit score is high enough that they lender feels secure doing this, yet the borrower clearly would only seek this type of loan if their finances has some detail that might be riskier (like being unemployed). But note the key phrase in that quote: "Consumers pay slightly higher interest rates..."
Here are some other pages about stated income loans. NOTE: I have no idea how reliable they are: