Transcript Document

Trends in the Marketplace: Exotic Mortgages
and Their Impact on Low to Moderate Income
Communities
Facilitated by David Berenbaum
Instructor, NCRC Academy
Introduction
• The market that borrowers see today is flooded
with enticing mortgage products boasting recordlow introductory rates, interest-only loans, option
adjustable-rate mortgages (ARMs), no money
down, and no income documentation required.
• Originally considered “nontraditional” mortgages
because of their high risk and small pool of
qualifying borrowers, these products are now
cropping up nationwide and becoming
mainstream.
• In 2005, 63% of new mortgages were interest-only
and adjustable-rate mortgages. Over an 18-month
period in 2004 and 2005, approximately one-third
of homebuyers did not put any money down for
their loan. And in California, Nevada and New
Jersey, negative amortization loans accounted for
27.5%, 20.1%, and 14.2% of non-agency
securitizations in the state.
• As lenders increasingly and excessively
target borrowers with these dangerous
products, the potential risk of payment
shock, negative amortization, loss of equity
and ultimately loss of home will also
continue to escalate for borrowers.
• We hope to orient member agencies to the
steps we need to take in order to inform our
clients about these products and to urge
regulatory agencies to prevent lenders from
making unnecessary and inappropriate loans.
The Wink-Nod
• “The proliferation of exotic mortgages has largely
occurred because more than 70% of mortgage
origination is through wholesale channels rather
than retail. The industry is incentivized to qualify
the borrower and will find the product to match
affordability. This places the lending industry in a
precarious position. On one hand they are
encouraging home ownership, but on the other
hand, it has been one of the factors in the run-up in
housing prices.” - John Miller, Miller Samuel
Joint Center for Housing Studies
• Between 5-10% of American Households will see their
Mortgage reset in 2006 - Harvard State of the Nations
Housing Report
• 6% likely
• Percentage to increase annually due to prevalence of
ARM’s.
• One-third of households spend more than 30 percent of
their income on housing, and more than one in eight
spends more than 50 percent. The number of such costburdened household jumped by 5 million from 2000 to
2003, the Harvard Center calculates.
• Overall 35 percent of mortgage loans in 2005
carried adjustable rates, up from just 18 percent in
2004.
• In the mid-1980s, more than 50 percent of
mortgages were adjustable, but back then shortterm rates were significantly lower than rates on
traditional 30-year mortgage loans.
• The difference now is that home buyers essentially
are grabbing loss-leader rates that are almost
certain to require sharply higher payments in a
year or two.
When exotic mortgages reset….
• Lets begin our discussion by introducing and
reviewing the most recent and exotic
mortgage products out there, along with the
types of borrowers who should steer clear of
them or, in the alternative, can reasonably
consider them.
• Foreclosure Risk
• Safety net for securitizers - “insurance”
• Twenty-nine percent of borrowers who took out
mortgages last year have no equity in their homes
or owe more than their house in worth - Study by
Christopher L. Cagan, director of research and
analytics for First American Real Estate Solutions,
a unit of First American Corp.
• That compares with 10.6% of those who took out
loans in 2004.
• Credit Suisse study looked at borrowers with good credit
who were at least 90 days late on their mortgages.
• Credit Suisse found that borrowers who took out
adjustable-rate mortgages in 2005 were three times as
likely to be delinquent on their payments after the first year
as those who took out ARMs in 2003 and 2004. Payments
on ARMs can adjust after as little as a month, or after
several years, depending on the terms of the loan.
• The study didn't include borrowers with option ARMs.
• Credit Suisse also found that borrowers who were
delinquent were more likely to have lower credit scores
and to have taken out piggyback mortgages, which
combine a mortgage with a home-equity loan or line of
credit.
• It also found that delinquency rates were shooting up in
California, where double-digit gains in home prices have
made affordability an issue.
• MBA reports increase in delinquency, roughly 4.7% of
residential mortgages were delinquent in the fourth quarter
of 2005. Excluding the effects of Hurricane Katrina,
delinquencies were 4.55%. That is up from 4.44% in the
third quarter and 4.38% at the end of 2004.
The Color of Money
Exotic Mortgage Types
• 40-Year
Mortgage
• Portable
Mortgage
• Interest-Only
Mortgage
• Negative
Amortization
Mortgage
• Flex-ARM
Mortgage
• Piggy Back
Mortgage
• 103s and 107s
• Home Equity
Line of Credit
• Loan
Modification
Mortgage
• Short-Term
Hybrids.
Forty Year Mortgage
• These products are similar to 30-year fixedrate mortgages, except that borrowers
stretch the payments out for an extra 10
years. Lenders, however, often charge a
slightly higher interest rate, up to half a
percentage point.
• Pros: A 40-year mortgage offers lower monthly payments than a 30year loan, while locking in today's attractive interest rate. On a
$300,000 mortgage at today's prevailing interest rates (6% for a 30year and 6.25% for a 40-year), a home buyer could save nearly $95
each month.
• Cons: By extending the length of the mortgage, the borrower increases
the amount of interest paid over the life of the loan. On that same
$300,000 mortgage, a home buyer would spend an additional
$170,030.42 using a 40-year mortgage.
• Good For: Experts recommend this product only for first-time home
buyers who don't plan on staying in the house for more than a few
years, and who can't afford the higher monthly payment associated
with a 30-year mortgage. NCRC is critical of this product.
Portable Mortgages
• In 2003, E*Trade launched a program called
“Mortgage on the Move” It allows home
buyers to lock in today's low interest rates
and take the loan with them should they
move into a new house a few years down the
line. A second mortgage can be used if the
buyer needs to borrow more money for the
next home.
• Pros: With current mortgage rates low — and by most
estimates likely to rise — locking in today's rate for the next 30
years is attractive.
• Cons: Interest rates for portable and second mortgages come at
slightly higher interest rates than do standard loans. A portable
mortgage is priced at 3/8 to 1/2 a percentage point higher, and
a second mortgage is often 3/4 of a percentage point higher
than a typical 30-year fixed-rate product, based upon NCRC
product review.
• Good For: People who know they will be moving in a
reasonable amount of time and want to lock in at a low rate.
Interest Only Loans
• With an interest-only loan, lenders allow
borrowers to pay just the interest portion of
their mortgage during the first, say, 10 years
of their commitment. After that, the loan
essentially becomes a new mortgage with
new interest and principal payments
stretched out over just 20 years.
• Pros: In addition to smaller monthly payments during the
interest-only repayment period, all of the money a borrower
puts toward the mortgage during this time period is tax
deductible.
• Cons: Should home prices stagnate, or depeciate, homeowners
would build up no equity during the interest-only years. Also,
monthly payments jump significantly once the principalpayment period begins. Most of these loans also carry variable
interest rates, further increasing a borrower's risk for higher
monthly obligations.
• Good For: Consumers who know (and remember, there are no
guarantees in life) that their incomes will rise significantly over
the next few years – not low to moderate income consumers.
Interest-only loans can also be a good option for professionals
who receive bonus payments as part of their compensation.
This product allows them to make minimum payments during
most of the year when cash is tight and then put down several
thousand dollars toward principal when they get their bonus
checks. NCRC is critical of this product.
Negative Amortization Loan
• This interest-only product allows buyers to
pay less than the full amount of interest
necessary to cover the costs of the
mortgage. The difference between a full
interest payment and the amount actually
paid each month is added to the balance of
the loan.
• Pro: An even smaller monthly payment than an interest-only
mortgage, during the first few years of the loan.
• Con: This is the riskiest mortgage lenders offer. Should
housing prices stagnate or fall, buyers would find themselves
"upside down" or in "negative equity," meaning they would
owe money to the lender if they sold their homes. NCRC is
critical of this product.
• Good For: Sophisticated borrowers with large cash reserves
who want the flexibility of lower payments during certain parts
of the year but plan to pay off their loans in large chunks
during other parts the year.
Flex-ARM Mortgage
• This is a cross between a hybrid ARM, which
offers a lower fixed rate during the first five or
seven years and then adjusts annually, and a
negative amortization loan.
• Each month the lender sends the borrower a
payment coupon that calculates four possible
payment options: a negative amortization, an
interest-only, a 30-year fixed and 20-year fixed.
The homeowner then decides how much he wants
to pay. (Some mortgages offer only an interestonly and a 30-year fixed option.)
• Pro: The bank does all the thinking. Each month it recalculates
the balance and tells the borrower how much he or she would
owe under different scenarios, giving the homeowner
significant flexibility.
• Con: Borrowers could end up owing more money on their
mortgage than they can fetch for their homes.
• Good For: People who like options and have large cash
reserves for when the mortgage payments increase during the
later portion of the loan. Like interest-only loans, Flex-ARMs
may be good tools for those who derive much of their income
from bonuses. NCRC is critical of this product because
consumers will of get into the trap of negative amortization.
Piggy Back Mortgage
• This product is actually two mortgages. The
first covers 80% of the property's value. The
second, which comes at a slightly higher
rate, covers the remaining balance
• Pro: In most cases, homeowners save money by taking out a
piggy-back loan (also known as a combo loan) since it allows
them to avoid paying costly private mortgage insurance when
buying a home with less than a 20% down payment. Plus, the
money that would have gone toward PMI is now tax
deductible, since it's going toward an interest payment.
• Con: As we mentioned, borrowers pay a higher interest rate on
the second mortgage. And rates can vary greatly depending on
credit score. Also, since the borrower has little equity in the
home, should it fall in value when it's time to sell, the borrower
would need to pay the difference in cash. NCRC is critical of
this loan product due to fair lending pricing concerns and the
fact that many predatory loans involve Piggy-Back mortgage
products.
• Good For: Folks with high salaries but little savings.
103’s & 107’s
• Who needs a down payment? Nowadays, people
can even borrow 3% to 7% more than the house is
worth.
• Good For: People with large cash reserves who
prefer to invest in, say, the stock market rather
than tying up their assets in real estate, and in
some cases when tied to comprehensive housing
counseling or special homeownership mortgage
initiatives, first time homebuyers.
Home Equity Line of Credit
• Known in the industry as HELOCs, these products
let buyers finance home purchases or use the
equity in their existing home using a credit line
rather than a traditional mortgage. HELOCs are
variable-rate loans tied to the prime rate. If a
HELOC is used as a first-position loan, all of the
interest is tax deductible. Here's how it works: The
buyer makes a down payment, and the credit line
covers the rest. HELOCs typically cover up to
90% of the appraised value of the home. Lenders
also offer up to 100%, at significantly higher
interest rates
• Pro: In this environment, HELOCs offer much more attractive
interest rates. A 30-year fixed-rate mortgage now carries a
6+% interest rate, Borrowers can also take out additional funds
against the equity in their homes without hassle or additional
cost.
• Con: Most HELOCs are structured for just 10 or 20 years,
rather than the customary 30. And since the interest rate is
variable, payments can be volatile, and can rise substantially
higher alongside the prime rate.
• Good For: People who plan on paying off their home quickly
but want the flexibility of access to more cash at a moment's
notice. This is not the typical NCRC members agency
constituent.
Loan Modification Mortgage
• With this loan, the borrower can subsequently change the
terms just by making a phone call, with a capped closing cost
each time of just $1,000 for every million dollars borrowed.
Moreover, the mortgage's duration isn't changed each time the
rate is modified.
• Pro: No paperwork is necessary, and closing costs are kept to
a bare minimum.
• Con: The added flexibility comes with a price tag of roughly
3/8th of a percentage point on every type of loan.
• Good For: People who like to follow interest rates. But
borrowers should make sure to factor in the $1,000 fee every
time they consider modifying their loan. To quote an industry
source, most of this products customers have financial planners
who manage their mortgages for them. Again, not the typical
NCRC member agency constituent.
Short-Term Hybrids:
• Like traditional hybrid adjustable-rate mortgages,
these short-term ARMs offer fixed-rate periods and
then the interest rate floats with the index they're
tied to. But since the fixed portion is for a very
limited time — say, six months or one year —
lenders offer very competitive rates.
• Pro: Very low interest rates during the fixed portion of the
loan. The initial monthly payments are relatively small.
• Con: Six months or a year can pass by in the blink of an eye
— and rates can change dramatically during that span. Back in
July 2003, for example, Charles Schwab offered a six-month
ARM with an interest rate of 2.995%. Today, that same
product sits at 5.1%. On a $250,000 loan, that would mean an
increase of $400/month.
• Good For: People who plan on moving in a very short period
of time, again, not the typical NCRC Member constituent.
The Legal Toolbox
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Appraisal & Valuation issues, FIRREA and USPAP
Federal Fair Housing Act – Steering Complaints
Truth In Lending Act (TILA)
Equal Credit Opportunity Act (Reg B)
Home Ownership & Equity Protection Act (HOEPA)
Home Mortgage Disclosure Act (Reg C)
Community Reinvestment Act - Wachovia Merger
Fair Debt Collection Practices Act
Real Estate Settlement Procedures Act (RESPA).
State & Local Protections
Fraud & Racketeering Arguments
FTC Act
Interagency Guidance
• Federal Agencies issue guidance on non-traditional
mortgages on September 29, 2006
• Guidance addresses interest-only and option
ARM loans
• Guidance does not cover fully-amortizing ARM
loans such as 2/28 and 3/27 loans
Interagency Guidance
• Fully Indexed Rate assuming Full Amortization
– Non-traditional loans should not be
underwritten using the initial teaser rate, but
should be underwritten using fully indexed rate
(rate at loan origination plus margin). Loans
should be underwritten based on the term of
the loans.
• Loans Permitting Negative Amortization –
Loans should be underwritten based on initial
loan amount plus any balance increase that
may accrue from negative amortization
Interagency Guidance
• Collateral Dependent Loans – Agencies
will consider loans to be unsafe and
unsound when the lender has not
qualified borrower based on ability to
repay but instead assumes that the
borrower will be able to sell or refinance
the loan based on the value of the
property.
Interagency Guidance
• Risk Layering – Combining non-traditional features such
interest-only, simultaneous second liens, or reduced income
documentation. When risk factors are layered, mitigating
factors are needed such as higher credit scores, or lower Loan
to Value ratios, or lower Debt to Income ratios.
• Stated Income – should only be used if mitigating factors
reduce risk. Generally, lenders should use W-2s, paystubs, or
tax returns in underwriting.
• Simultaneous Second Liens or Piggyback – Borrowers with
minimal equity should not have delayed or negative
amortization.
Interagency Guidance
• Introductory Rates – Lenders should minimize spread between
introductory rates and fully indexed rates so that borrowers do
not experience payment shock.
• Brokers – Monitor third parties including brokers to ensure that
brokers are adopting the lender’s standards. Terminate
relationships with brokers as needed.
Interagency Guidance
• Consumer protections – Disclosures recommended before
the disclosures required by the Truth in Lending and other
laws. Disclosures should occur when consumes are
shopping and not only when Good Faith Estimate is issued
and consumer has paid fees.
• Advertising – Lenders should describe risks as well as
benefits of non-traditional loans
• To minimize chances of payment shock, disclosures could
include the maximum monthly amount a consumer could
pay.
Interagency Guidance
• Consumer Disclosures – Borrowers should be clearly informed
of prepayment penalties and the possibilities of negative
amortization for option ARM loans. Consumers should be
alerted to the price premium associated with reduced
documentation loans.
• Clear disclosures of Impacts of Choices – Borrowers should be
clearly informed of how their choice of monthly payment options
affects the amount paid off each month or whether negative
amortization results
• Avoid deceptive practices such as emphasizing benefits and
“obscuring significant risks” to consumer.
Subprime Guidance
• The non-traditional guidance did not cover
subprime 2/28 and 3/27ARM loans. The
regulators have just issued proposed guidance to
cover 2/28 and 3/27 loans. The proposed
subprime guidance is very similar to the nontraditional guidance. It is good overall, but should
also apply to prime ARM loans
• Freddie Mac adopted many elements of the
proposed subprime guidance a few days before the
agencies issued the proposed guidance.
Building Coalition
• Building “coalition” to address the issue, change practices and
create a safety net – Group exercise on next steps and a
discussion of the NCRC Consumer Rescue Fund.
• Nontraditional mortgages pose heightened risk to sub-prime
borrowers. Already beginning the life of their loan with higher
interest rates due to credit blemishes, sub-prime borrowers are
often more sensitive to rate fluctuations than prime borrowers.
CFA Study
• Exotic or Toxic? An Examination of the
Non-Traditional Mortgage Market for
Consumers and Lenders - Consumer
Federation of America, May, 2006
• Significant Shares of Non-Traditional Mortgage Borrowers
Earn Less Than $70,000 Annually. More than one third
(36.9%) of interest only borrowers earned below $70,000
annually and about one in six (15.6%) earned under
$48,000 annually. More than one third (35.0%) of
payment option borrowers earned under $70,000 annually
and about one in eight (12.1%) earned between under
$48,000. ($70,000 was about the median for Atlanta,
Philadelphia and Chicago metropolitan areas, according to
HUD figures for 2005, and the national median is
$44,300.)
• African Americans and Latinos More Likely to Receive
Payment Option Mortgages: Latinos are nearly twice as
likely as non-Latinos to receive payment option mortgages.
One in fifty (2.1%) non- Latino borrowers received
payment option mortgages compared to the 4.0% of
Latinos that received payment option mortgages. African
Americans were 30.4% more likely than non-African
Americans to receive payment option mortgages. 2.2% of
non-African Americans received payment option
mortgages compared to 2.9% of African Americans.
• African Americans were more likely than nonAfrican Americans to receive interest-only loans.
Nearly one in ten (9.0%) of African Americans
received interest-only mortgages, 11.7% higher
than the 8.1% of non-African Americans that
received interest-only mortgages.
• Many Non-Traditional Borrowers Have Only
Average or Even Weaker Credit Scores. More
than half (53.8%) of payment option borrowers
and nearly two-fifths (38.0%) of interest only
borrowers have credit scores below 700. More
than one fifth (21.4%) and about one in eight
(12.1%) interest only borrowers had credit scores
below 660.
• The majority of these two types of non-traditional
mortgages are used to purchase homes. Nearly
four out of five (79.0%) interest-only mortgages
and nearly three fifths (57.5%) of payment option
loans were used to finance the purchase of a home.
The high proportion of purchase mortgages in the
non-traditional mortgage portfolio tends to support
the contention that the increased use of these
mortgage products is related to the rapidly
escalating cost of housing.
CFA’s Bottom Line
• Many borrowers are increasingly relying upon non-traditional
mortgages as a means to buy homes they could not otherwise
afford. Non-traditional mortgage products typically offer initial
lower monthly payments than traditional fixed-rate loans. But
when these loan terms reset after a brief period, usually 2 to 5
years, consumers could be vulnerable to payment shocks,
making their homes suddenly unaffordable and potentially
ruining their finances.
• For example, a $200,000 home with adjustable rate (ARM) nontraditional mortgage, an interest only ARM payment would rise
by 54% and a payment option ARM payment would rise by
123% if the interest rate rose from 5.00% to 6.50%.
• Question & Answers
• For more information, please contact me at (202)
464-2712 or [email protected]
Thank you for participating today!