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Monday, December 19, 2005 | There’s a mortgage deal out there for everyone. San Diego lenders say that, these days, they can find anyone a loan who wants one.
But the easy availability of financing, and the implications of providing high-risk loans to high-risk borrowers, has real-estate experts and analysts worried. They are concerned that many ambitious homeowners have over-extended themselves – something that may leave them vulnerable in the event of unforeseen circumstances.
And if these homeowners are vulnerable, so is the housing market in San Diego. Analysts say that if too many borrowers default, the market could become flooded with homes for sale, thus pushing prices down.
Raphael Bostic, director of the Master in Real Estate Development Program at USC’s School of Policy, Planning and Development, said this is possibly the most critical issue facing San Diego’s real estate market today.
“You’re looking at the prospect of many, many homes going into default and disclosure, which then disrupts basically the whole housing market,” Bostic said.
John Marcell, president of the Mortgage Brokers Association of California, said interest-only loans and other higher-risk loans have only become a mainstream borrowing option in the last few years. Marcell said this increase is due largely to California’s skyrocketing home prices.
When a borrower takes out an interest-only mortgage, they agree to only pay the interest on the money they have borrowed. Therefore, as they make monthly payments, their outstanding balance remains the same. These mortgages are usually interest-only for a specified period of time, often 10 years.
Bostic and others argue that these loans are inherently more problematic than traditional fixed-rate mortgages because borrowers do not build equity in their homes unless property values rise. In the event that home prices fall, borrowers can easily find themselves paying interest on a loan that is not netting them any value.
Three or four years ago, Marcell said, many of today’s borrowing options simply did not exist. As prices have risen, he said, traditional mortgage plans have proved unwieldy for many would-be home owners and lenders have become more and more ingenious when it comes to offering mortgages.
“Everybody’s needing to do new loans and find new ways to make money,” said Rishon Wagner, vice president of The Mortgage Company in Poway.
Bostic called the new breed of mortgages “risky.” That risk is double-edged, he said. Not only do these loans place a higher burden on borrowers, he said, but they are also easier to qualify for than traditional 30-year fixed-rate mortgages.
Because of the hazards of these new loans, Bostic said, borrowers are increasingly placing themselves at the mercy of factors beyond their control. Should the new breed of borrowers run into trouble, he said, they could easily find themselves defaulting on their loans.
“If these households were to face stresses in their lives, if they had a health accident or if the roof blew off their house, or if their car needed major repairs or if, God forbid, they were laid off, with these high-burden mortgages, these households are not going to have any kind of buffer to weather those sorts of storms,” Bostic said.
There are two major risks with an interest-only loan. One of them approaches when the interest-only period ends and in order to begin paying the loan off, monthly payments immediately ramp up to potentially unsustainable levels. The second worry comes with the fact that because borrowers are not paying off any part of their loans, they may end up with little or no equity in their home.
The only equity comes from the rising value of the house they purchase. But if the home’s value sinks or stays level, the borrower will not build equity and could potentially end up owing more on their mortgage than the house is worth.
Traditional mortgages force buyers to pay off their loans little by little thereby helping create equity in addition to that which the value of the house creates.
Without a buffer like that, Bostic said, these borrowers will have no choice but to foreclose if they can’t pay off their loan by selling the house. An increase in foreclosures traditionally results in lower property values as the market responds to the increased supply of property.
Alan Gin, a professor of economics at the University of San Diego’s Burnham-Moores Center for Real Estate, said another factor that could land these borrowers in trouble is interest rates. If interest rates rise, payments on a non-fixed-rate mortgage go up, and borrowers are more likely to foreclose.
Though Gin doesn’t foresee a severe spike in interest rates – his prediction is for short-term rates to rise 1 percent in the next year – he said even a modest rise in rates could have a marked effect on debtors. Add to the equation a possible decrease in home values, he added, and the market could be in serious trouble.
Not everyone agrees with the skeptical view of non-traditional mortgages, however.
Mike Zarro, office manager at Coast Mortgage Company in La Jolla, doesn’t like to call interest-only mortgages “risky.” He said the loans that have become popular in the last few years are simply the next evolutionary step in home purchase financing.
Thirty years ago, Zarro said, a borrower only really had one choice for a loan: a 30-year fixed-rate mortgage. When interest rates rose drastically in the early 1980s, Zarro said, the private and public sectors came out with the adjustable-rate mortgage as a solution.
“In those days, that was considered risky,” said Zarro. “Today, it’s an absolute standard. So the interest-only, that some people are calling risky today, 20 years from now, might be an absolute standard as well.”
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