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Last week, the Senate Banking Committee heard testimony about the possibility of a housing bubble in the country.

They’ve certainly moved quickly in their crash course in bubble-ology – today they heard from federal banking officials about the possible ramifications of exotic mortgages.

“Exotic” is the term used to describe either interest-only or negative-amortization loans, the popularity of which has increased significantly in recent years, especially in California’s heated housing markets. Interest-only loans allow borrowers to pay just the interest, at a fixed rate, for a stated period before their payments kick up to include some of the principal. The negative-amortization option on an adjustable-rate-mortgage provides an even lower payment for homeowners – that option doesn’t require borrowers to pay even all of the interest accrued in their introductory period, meaning their debt actually grows while the loan is in re-payment.

A lot of these loans are due to reset in the coming months. That means the introductory periods will be over and homeowners will face dramatic increases in their monthly payments – some could double. That payment shock could mean less money spent on discretionary items, and those effects could ripple through the economies of cities where the loans are major players, like San Diego, where nearly 70 percent of the new loans taken out so far this year have been exotic mortgages, according to FirstAmerican LoanPerformance.

Here’s a snippet from a DowJones MarketWatch summary of the hearing this morning:

The regulators testified that defaults and foreclosures on nontraditional loans remain very low, but they emphasized that it’s too soon to tell what might happen if the economy slows, interest rates rise and housing prices stagnate.

Mortgage-industry representatives at the hearing insisted that they are merely responding to consumer demand. It’s not up to the mortgage broker or banker to determine what’s a “suitable” loan, said Robert Broeksmit of the Mortgage Bankers Association.

Click here to access a link where you can listen to the hearing or read the testimonies of the presenters this morning.

KELLY BENNETT

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