The Mortgage Trap By
Dean Foust,
with Peter Coy in New York, Sarah Lacy in San Mateo, Rishi Chhatwal in Atlanta, and bureau reports
BusinessWeek
Online Lenders are cranking out an ever-growing array of financing schemes and lowering standards to keep the housing boom going Nicki
Randolph, a San Francisco real estate agent, hasn't been scared off by talk of a housing bubble. Although she already owns both a home and a condo in Palm Springs, Calif., Randolph just closed on a third property -- dropping more than $1 million on a 1,400-square-foot loft in the heart of San Francisco. How does she juggle so many properties in the overheated California market? Lots of leverage, thanks to banks all too willing to provide ever more. To
finance her loft purchase, Randolph took out a mortgage that lets her pay only interest for the first five years -- a tactic that helps her ease into the hefty monthly payments. "Fears that the market is going to crash are way overstated," she says confidently. "It's a seven-mile-by-seven-mile city and a premier place people want to live. You have to be more aggressive here because the prices are so high." PRESSURE
KEEPS BUILDING. Randolph's story is a familiar one -- and it shows the lengths to which buyers are willing to go to snatch up real estate as well as the extremes lenders will stretch to accommodate them. As prices continue to skyrocket in much of the country, banks and lenders are cranking out an ever-growing array of products ranging from no-money-down or interest-only mortgages, to special "Payment Power" loans that allow homeowners to defer monthly payments altogether twice a year. Such
creative financing is letting even marginal buyers purchase houses with price tags that used to appeal only to the rich and famous. In the process, banks and mortgage companies appear to be taking on more risk than ever before -- and if rates rise sharply or prices tumble, many of their customers could find themselves in deep trouble, too. All
those innovative mortgage products are a sure sign that lenders are doing everything they can to keep the housing boom going and to capitalize on yet another round of falling interest rates that no one expected. There are plenty of other signs of frenzy as well. Home appraisers complain that mortgage originators are demanding the optimistic appraisals needed to close on loans. "They started warning me to 'be a team player' and to 'hit the number' they needed to seal the deal," says Robert Burnitt, an appraiser in Midlothian, Tex. SUPPORTING
A STRETCH. Enticed by juicy commissions from all those deals, others are jumping into the mortgage biz. Among them are John Switzer, an 18-year-old high school grad from New Bern, N.C., who put off college so he could start work as a mortgage rep for Houston-based Franklin Bank Corp. (NasdaqNM:FBTX
- News).
"Right now, mortgages are a little more interesting" than college studies, he says. Yet
nothing screams "frenzy" louder than the huge popularity of innovative -- and risky -- mortgage products that allow buyers to stretch for those million-dollar studios and multimillion-dollar suburban colonials. With interest-only mortgages now offered by everyone from ditech.com to Washington Mutual (NYSE:WM
- News),
such loans now account for 20% of all new mortgages, up from under 5% two years ago. Option
adjustable-rate mortgages, or "option ARMs," have also become all the rage in superheated markets such as California and Washington, D.C. With an option ARM, borrowers can choose among three different payment plans each month, continually changing what they fork over as their budgets shift. The options: a regular payment of both principal and interest, just the interest, or one that may not even cover the interest -- so the overall balance owed on the mortgage could continue to grow. TREND
TOWARD RISK. The question is, will the proliferation of interest-only and option ARM mortgages leave many buyers strapped down the road, causing higher default rates? David Liu, a mortgage strategist for UBS in New York, notes that after similar products were introduced in the red-hot California market in the late 1980s, they ultimately incurred a default rate that was three times as high as conventional mortgages when the local economy went into recession in the early '90s. Already
there are signs that current option ARM borrowers are straining to make their monthly payment: Liu notes that among a bundle of mortgages originated by Washington Mutual and securitized into the secondary market last year, fully 60% of borrowers made only the minimum payment this past March. "That's definitely a sign that people are stretching,"says Liu. <
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