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Monday, Aug. 28, 2006 | Julie Haas is a scientist. So when she researched buying a condo two years ago, she gathered all of the relevant statistics, crunched the numbers on her financing options, and even worked out a worst-case scenario: “If I sold two to three years later for exactly what I paid for it, it would break even with renting,” she said.
A post-doctoral neuroscience researcher at the University of California, San Diego, Haas figured she’d stay in the San Diego area for three to five years, depending on her research funding. And so she financed her home with an option adjustable-rate mortgage that allowed her to pay back only the interest on the loan for two years.
But she couldn’t plan for the market’s fluctuations. Soon after buying, she watched some of her neighbors’ comparable units skyrocket, selling for a profit of $50,000. But recently she’s watched them depreciate right back to her starting price.
“I’m back to ground zero,” she said. “Ironically, I’m back to my worst-case scenario.”
Haas’ current research funding will end in January. Her mortgage is due to reset – to start including payments on the principal of the loan – in April. Her monthly payments will double. And Haas fears her condo will have depreciated even more by then.
“I’m very scared that I’m just going to be stuck here,” she said.
Haas’ experience with the unpredictable ups-and-downs of the San Diego real estate market is common. In the housing heyday a few years ago, people were scared of getting priced out of the market, so many jumped into homes, financing them any way they could.
Like Haas, many homebuyers have been choosing mortgages that have a fixed low rate for a stated period. The mortgages adjust years later according to interest rates for the rest of the term. The appeal of these mortgages is that they allow borrowers to enter a housing market they might not have otherwise accessed through low monthly payments. Some choose to pay only the interest. Others pay only a portion of the interest accrued each month, meaning that their debt incurred actually grows – rather than shrinks – for a period as the loan ages.
These so-called “exotic” loans are founded on the assumption that real estate always goes up – that by the time the loans are due to reset, the borrowers’ home values will have increased enough that they can, if they need to, use that equity to refinance the loan and avoid the substantially larger payments ahead.
When those loans reset, the monthly payments can be kicked up by a few thousand dollars a month. Sometimes, the payment can more than double.
So with the low introductory period of many loans about to end and a cooling housing market, a number of homebuyers are facing the prospect of a sizable jump in their monthly payments – and experts are contemplating the impacts on an already uncertain housing market.
But despite that cooling market, where equity is no longer “guaranteed,” the exotic loans are still hot. In the first five months of this year, 67.8 percent of the purchased and refinanced mortgages in San Diego were either interest-only or negative-amortization loans, according to First American Loan Performance.
The loans are just as popular as they were last year, and even more so than a few years ago, when housing prices were vaulting up. And the nationwide trend is even more pronounced in San Diego.
Last year, 68.8 percent of local mortgages were exotic loans. In 2004, these types of loans made up 57.7 percent of the pie. Only a quarter of mortgages were interest-only or negative-amortization in 2003, and only 11 percent were exotic in 2002.
The rising prices have some market analysts worried that borrowers won’t be able to afford the increased mortgage payments, spurring the likelihood of increased foreclosures and decreased consumer spending in the economy as a whole.
Peter Dennehy of Sullivan Group Real Estate Advisors said while prices have entered year-on-year-declines, affordability across the county is still low, and so the low-payment exotic loans still have a sizable target market.
“People are willing to give [consumers] the loans,” Dennehy said. “Whether it makes sense to do it in an era of declining prices, probably not.”
And that’s causing some mortgage brokers to do a little soul searching.
“The problem with our industry is that we’re so focused on the transactional, we don’t realize that there are real people on the other end of these loans,” said Dan Holbrook, president of the AtVantage mortgage brokerage firm in Carlsbad. “We don’t look beyond the 30, 60, 90 days it takes us to process the mortgage.”
Amy Crews Cutts, deputy chief economist for national mortgage giant Freddie Mac, estimates 2 million families nationwide face scheduled resets in 2006, and 2.7 million families’ loans are schedule to reset next year. However, only about a quarter of those loans will actually reset, she said – the other 75 percent will likely refinance or get out of the home.
Nevertheless, the number of people facing higher monthly payments is very high – and growing.
These loans used to draw people in because of their inherent safety net: If homeowners got to the reset phase and couldn’t afford the new payment, their house had often appreciated at least 5 percent and they could refinance or get out of the home, sometimes even at a profit.
But, with median price decreases of 1 to 2 percent year-on-year, borrowers don’t have that option anymore.
That’s where Haas finds herself. Her parents put a large down payment into her condo to help keep her payments low. They pushed her to buy the home.
“They’ve done fabulously in real estate,” Haas said. “But they’re also the generation where you got a job and stayed there for 10, 15, 20 years. Nobody does that anymore. I don’t know when I’ll ever move somewhere and be able to say, ‘I’ll be here for 10 years.’”
Her parents, real estate agent and mortgage lenders all said the same thing: “Things will be so much better in three years.”
Now that they’re not, Haas doesn’t think anyone but herself should carry the responsibility of her choice.
“It’s my job to make the decision, right?” she said. “I don’t make the decision based on what people tell me. That’d be incredibly stupid.”
But many long-time industry professionals think it’s time to step up the integrity and responsibility in lending.
It’s the homebuyers’ desperation to get into a house, even if they can’t afford to, that concerns them. They say lenders need to be helping buyers understand the loans they’re taking out. And they want to see buyers to be realistic and educate themselves – before they sign on the dotted line.
“[Lenders] should have the integrity to look the person in the eye and walk them through what it means,” Crews Cutts said. “A mortgage broker doesn’t have an incentive to do that. Once the loan is made, he’s done with it. He has no skin in the game.”
Holbrook wonders if the mortgage industry would benefit from malpractice insurance like doctors have – a bad piece of advice could change someone’s quality of life forever, he said.
“I’m condemning myself and the industry that I’m in,” he said. “But I challenge this industry to raise the bar, to realize that we’re playing with real people’s lives. We’re more than chauffeurs and tour guides.”
“I see it coming on like crazy now,” said Paul Smith at California Home Loans Professionals of the number of borrowers who will have to struggle through loan resets.
Smith is especially concerned about those who have used a negatively amortized option loan to tap into their home’s equity. “It’s a lot different than when their parents bought homes,” he said. “People don’t live that way anymore. They buy their cars with their equity; they pay their bills with their equity.”
There are two categories of people who take out these loans said, Craig Bramlett, president of Cal Pacific Mortgage in San Diego. The first is those who could feasibly make higher payments, but choose interest-only for a while to invest their money in other ways. The other category: those who can afford only interest-only or negative-amortization payments, and who rely on the “promise” of home appreciation to help them when the reset comes. Those are the people Bramlett and others worry about, and there aren’t just a few of them.
“From what we hear, there’s a lot of people in that boat,” Bramlett said. “They’ve chosen to do those loans, and they can’t afford them.”
“It could be disastrous,” he said. “They’re not getting good financial advice. They’re talking to a lender who’s never been through a downturn.”
Dennehy, of the Sullivan Group, agreed with Haas that there is greater transience in the current generation of homebuyers. And that contributed a lot to the acceleration of the market, he said.
“Real estate is age- and stage-related,” he said. “And I’m not a big fan of people buying things they can’t afford. That probably pushed the market farther than it should have gone.”
Bramlett says many people he talks to can’t explain the loans that they have.
“They get really excited about being able to make a payment, and all of a sudden they’ve forgotten to ask all the right questions,” he said.
One of those questions that only a few borrowers remember to ask is about the “recapture period” on a negative-amortization loan. Borrowers usually at least know how long they’ll be able to make the minimum or interest-only payments – usually up to about five years. But what some don’t realize is that if the interest deferred to the principal “lump” causes that sum to reach a point between 110 and 125 percent of the original loan, depending on the institution, that mortgage could automatically reset. In that case, the borrower has to start making the principal payments.
The phenomenon of exotic loans has spawned an onslaught of new lenders and mortgage brokers. Now, those who want to stay around in a cooler market will have to up their standards, Crews Cutts said.
“Integrity tends to go hand-in-hand with professionalism,” she said. “The ones who got in because money was falling out of the sky have already moved on to wherever the next can’t-lose business deal is.”
Charles Jolly, president of the San Diego Association of Realtors, said while it’s not the real estate agent’s responsibility to inform the buyer about all of the ins and outs of loans, he believes that good Realtors often provide that service to their clients. But that shouldn’t relieve the buyer from responsibility.
“Buyers ought to be reading the [promissory] notes,” he said. “Your loan brokers aren’t going to read it to you. Your Realtor might help you understand it. But you’re the one who’s going to have to live with it long-term.”
With the wealth of information easily accessed by the average person, Holbrook said brokers, loan officers and real estate agents will need to earn their commissions by doing more than just providing statistics.
“We were the gatekeepers, the Billy Goats Gruff of information,” he said. “Now the consumer can sit in their den at 3 in the morning in their underwear and look for real estate.”
He said the expectation for the industry is low – that people don’t expect the lenders or the agents to really provide in-depth analysis. But that’s changing, he said.
“We’ll start thinking like financial planners, thinking beyond the close of escrow,” he said. “If we can do that, we might be able to help.”