New Mortgage Menu Isn't All Easy to Digest

August 1, 2005

Pamela Yip

Not long ago, financing a home was like ordering from a menu with only one item: You got what was available, which was the plain-vanilla, 30-year fixed-rate mortgage.

But today, lenders are offering hundreds of mortgage products with creative terms. You can pay the interest only for a few years, choose your monthly payment or even close on your loan with little documentation of your income.

The trick, experts say, is that these hot products can be time bombs for consumers who don't consider the long-term consequences of such easy credit.

"Mortgage programs now are not just one-size-fits-all," says Anthony Hsieh, president of www.LendingTree.com, an online lender. "Some people are stretching today because of the runaway housing prices."

You can thank technology for the smorgasbord of mortgages out in the market.

"Software has made it possible to maintain consumer protections and to instantaneously recalculate loan payments," says Doug Duncan, chief economist of the Mortgage Bankers Association. "It's allowed companies to make what used to be a paper-and-manual process an electronic process and dramatically lower the cost."

More sophisticated credit analysis plays a role, too, because lenders can more accurately judge their risks while still enticing borrowers with lower rates.

"There are so many more programs these days, it could be confusing to the consumer," Hsieh says. "The lower the monthly payment, you're giving up something else."

Source: (c) 2005, The Dallas Morning News. Distributed by Knight Ridder/Tribune News Service.

Mortgage lenders loosen standards despite risks

By Ruth Simon, The Wall Street Journal

Mortgage lenders are continuing to loosen their standards, despite growing fears that relaxed lending practices could increase risks for borrowers and lenders in overheated housing markets.

Novel loan products have helped fuel much of the run-up, which continues to defy expectations, as reflected in home-sales data released Monday. Existing-home sales hit another record in June, up 2.7 percent from May's heated levels, according to the National Association of Realtors. Median home prices rose 14.7 percent from June 2004.

But lenders are making it still easier for borrowers to qualify for a loan. They are lowering the credit scores needed to qualify for certain loans, increasing the debt loads borrowers can carry and easing the way for borrowers to get loans while providing little documentation. In some cases, lenders are easing standards not only for homeowners, but also for the growing number of people buying residential real estate as an investment.

In one recent move, Chase Home Finance, a unit of J.P. Morgan Chase & Co., this spring began allowing some of its customers to take out home-equity loans and lines of credit without having their incomes verified. Under the new program, income verification isn't required for home-equity loans of up to $200,000, provided that the borrower's total mortgage debt doesn't exceed 90 percent of the property's value or $1.5 million. The change "is not for all customers -- it's only for customers with the very highest credit rating," a company spokeswoman says. Loans with little or no documentation have grown in popularity industry-wide.

Last month, Wells Fargo & Co. began allowing buyers of investment properties in some parts of the country to take out interest-only mortgages, which let borrowers pay interest and no principal in the loan's early years. Another recent change in some markets boosts the standard for how much total debt and housing expenses certain borrowers can carry to 45 percent of their income from 38 percent.

A Wells Fargo spokesman says the company doesn't discuss specific changes, but that it consistently monitors economic conditions in its major markets and will at times "modify our lending guidelines in a specific market." He added, "On a national basis, we have made no substantive changes to our lending policies and practices."

Banking regulators, meanwhile, are paying closer attention to mortgage lending practices. "Lending standards are continuing to ease," says Barbara Grunkemeyer, deputy comptroller for credit risk at the Office of the Comptroller of the Currency, which is putting the finishing touches on its annual survey of bank underwriting standards. Federal Reserve surveys of bank loan officers show that lenders have tended to loosen standards since early 2004, following a period of relative tightening.

In some cases, lenders have tweaked their offerings by reducing the minimum credit scores needed to qualify for certain loans. Countrywide Financial Corp., for instance, recently cut by 20 points the minimum credit score borrowers with bigger loan amounts need to qualify for one of its popular loan programs. A Countrywide spokeswoman says the change was designed to make the terms of this loan consistent with its other offers.

The continuing loosening of lending standards has helped push the homeownership rate to a record 69 percent of U.S. households. Mortgage delinquencies, meanwhile, have remained low, with just 1.08 percent of residential mortgages in foreclosure proceedings at the end of the first quarter, down from 1.17 percent five years earlier, according to the Mortgage Bankers Association. Low interest rates and rising home prices have helped keep delinquencies down by keeping monthly payments in check and making it easy for borrowers who run into trouble to refinance or sell their homes at a profit.

But the lowering of standards has also raised concerns that some borrowers may run into trouble making their payments, and that defaults could rise. In May, in response to concerns about looser underwriting standards, bank regulators issued their first-ever guidelines for credit-risk management for home-equity lending. Regulators are working on new guidelines for mortgage lenders.

In addition, bank examiners "are looking more at how banks originate first mortgages today than they were a year ago," says Ms. Grunkemeyer of the Office of the Comptroller of the Currency. "The reason they are doing it is because the mortgage products (lenders) are originating are higher risk."

Washington Mutual Inc. says it's loosening its guidelines on some products while tightening them on others. In June, it began offering home-equity lines of credit to borrowers who buy condominium units as an investment or as a second home. Another recent change lets borrowers who buy a second home or investment property finance as much as 90 percent of the home's value, up from 75 percent. Sales of investment properties have surged recently, adding fuel to the heated housing market.

The Seattle-based lender says it has also moved to toughen some standards. Earlier this year, Washington Mutual began setting stricter limits on the size and loan-to-value ratios for loans above $7 million. It is also reassessing its credit standards for investment properties and second homes, says Jim Vanasek, the company's chief enterprise risk-management officer.

"There's been a growing awareness over the past six to nine months that the risks are starting to increase with the very, very rapid price escalation we have seen," Mr. Vanasek says. "I would be surprised if mortgage lenders don't do some degree of reining in or tightening over the next several months."

So far, evidence of tightening has been hard to detect. "The trend toward relaxing standards is still relatively strong," says Gibran Nicholas, a mortgage broker in Ann Arbor, Mich. Mr. Nicholas expects this pattern to continue as long as foreclosure rates remain low and demand remains high from investors who buy bonds backed by pools of mortgages.

Some lenders say they are being forced to relax their standards to remain competitive. U.S. Bank Home Mortgage, a unit of U.S. Bancorp, says interest-only mortgages and loans with less-than-full documentation now account for about 10 percent of its business, up from just 4 percent a year ago.

"We're just offering the product that a lot of our competitors have offered," says U.S. Bank President Dan Arrigoni. "If anything, we have to think about loosening them if we want to compete." But, he says, U.S. Bank has resisted pressures to offer increasingly popular option adjustable-rate mortgages -- which carry starting rates as low as 1 percent and give borrowers multiple payment choices -- because the bank considers them too risky.

Lenders also say that advances in technology and data analysis enable them to do a better job of determining who is a good credit risk. "One of the things that is often missed is that we've become much better predictors of loan performance with automated underwriting systems and appraisal practices," says Jerry Baker, president and chief executive of First Horizon Home Loan Corp., a unit of First Horizon National Corp.

First Horizon recently reduced the credit scores and boosted the loan-to-value ratio allowed on limited and no-documentation loans that it sells to investors through Wall Street. The bank says such loans represent a tiny portion of First Horizon's volume.

The loosening of standards also shows up as products that were initially geared toward the most sophisticated borrowers -- such as option ARMs and interest-only loans -- have become more mainstream. A recent analysis by UBS AG shows that the average credit scores for borrowers with option ARMs has declined over the past three years. In addition, more than 22 percent of the borrowers who took out option ARMs this year financed more than 80 percent of the purchase price, up from 12 percent of borrowers in 2004 and less than 2 percent in 2002, according to the UBS analysis, which looked at loans sold to investors.

Similarly, interest-only mortgages, which were first aimed at wealthy borrowers, are increasingly being offered to people with poor credit. Interest-only mortgages accounted for 30 percent of the subprime loans originated in April, according to UBS, up from 14 percent in all of 2004. Average credit scores and other measures of credit quality have also been declining, according to UBS.

Easing Up

Here's how mortgage lenders are loosening their standards:

• Reducing the minimum credit score borrowers need to qualify for certain loans.
• Allowing borrowers to finance more of a home's value or carry a higher debt load.
• Introducing new products designed to lower borrowers' monthly payments for an initial period.
• Letting borrowers take out loans with little, if any, documentation of income and assets.

A Field Guide to Innovative Mortgages

Here are some of the novel loan products that have been gaining popularity and helping fuel the housing boom:

LOAN PRODUCT: Interest-only mortgages
COMMENT: These allow borrowers to pay interest and no principal in the loan's early years, which keeps payments low for a time.

LOAN PRODUCT: Option adjustable-mortgages
COMMENT: These loans carry introductory rates of as low as 1 percent and give borrowers multiple payment choices. But borrowers who elect the minimum payment can see their loan balance rise.

LOAN PRODUCT: Piggyback loans
COMMENT: These combine a mortgage with a home-equity loan or line of credit, allowing borrowers to finance more than 80 percent of the home's value without paying for private mortgage insurance.

LOAN PRODUCT: No-documentation and low-documentation loans
COMMENT: Under these programs, borrowers can take out a loan while providing little if any documentation of their income or assets.

Source: WSJ research

Rate Probability: Sideways to Slightly Higher

The Bond Rate Monitor

So what does China have to do with mortgage rates in the US? Enough to stall an upward trend in the mortgage backed securities market, which is exactly what happened last week. But will rates continue to rise, or is the worse part over?

Rates were improving last week until China announced that they were going to let their currency float against a myriad of other foreign currencies last week. Before this announcement their currency, the Yuan was fixed to the US dollar. This announcement caused a panic in the bond market which feared the heavy Chinese investment in US bonds might be discontinued in the near future. However after digesting the Chinese surprise announcement bonds rallied on Friday and ended at a support ceiling.

This of course means the big question is - Will bonds rally enough to break through the ceiling or reverse course again and head down, thereby pushing rates higher? Unfortunately, if this weeks full schedule of economic indicators is on target, the economy will continue to do better which generally is bad for rates. However, for rates to move noticeably higher the economy will have to post higher improvements than the market expects, which we view unlikely. Therefore, it seems rates will continue to bounce around between the support ceiling and floor this week and maintain their overall downward trend, which means rates will continue to slightly worsen.

Mortgage interest rates rise

Rates on 30-year, fixed-rate mortgages rose to 5.73 percent this week from 5.66 percent last week, Freddie Mac reported in its nationwide survey.

Rates on 15-year, fixed-rate mortgages, a popular choice for refinancing, rose to 5.32 percent from 5.25 percent. For one-year adjustable rate mortgages, rates increased to 4.42 percent from 4.39 percent. Rates on five-year hybrid adjustable rate mortgages rose to 5.26 percent from 5.15 percent.

The average rates do not include add-on fees known as points. Thirty-year mortgages and 15-year mortgages each carried an average fee of 0.4 point. One-year ARMS had an average fee of 0.6 point, and five-year ARMS carried a fee of 0.5 point.

Associated Press

Fed releases meeting minutes

The Federal Reserve won't use monetary policy to deflate what some economists say is a "bubble" in the U.S. housing market, the minutes of the Fed's June 29-30 meeting showed. Federal Reserve staff made a special presentation on housing valuations to the interest-rate setting Federal Open Market Committee during the two-day meeting, according to the minutes.

"A strategy of responding more directly to possible mispricing" of assets such as housing "was seen as very unlikely to contribute, on balance, to the achievement of the committee's objectives over time," the minutes of the FOMC meeting showed. The Fed document cited "the unavoidable uncertainties associated with judgments regarding the appropriate level of and likely future movements in asset prices."

Bloomberg News

Greenspan expresses mortgage concerns

Issuing an otherwise cheery outlook for the U.S. economy, Federal Reserve Chairman Alan Greenspan warned homeowners about risky mortgages.

BY NELL HENDERSON
Washington Post Service

WASHINGTON - Federal Reserve Chairman Alan Greenspan said Wednesday that certain types of increasingly popular, risky home mortgages could prove "disastrous" for some borrowers betting on ever-rising house prices.

"There's potential for individual disaster there," Greenspan said on Capitol Hill, issuing his strongest warnings yet about the potential pitfalls for consumers and lenders in the nation's red-hot housing market.

Historically, the kind of rapid price appreciation seen recently "does not go on" forever, Greenspan said during a hearing of the House Financial Services Committee.

RISKY MORTGAGES

However, some borrowers are assuming such continued gains will enable them to pay back various mortgages that initially involve very low costs, he said.

Those mortgages have surged in popularity over the last year, enabling individuals and families to buy houses they could not otherwise afford, and helping to further pump up prices, he said. But some borrowers could find it difficult to make the required loan payments if interest rates rise sharply or their incomes fall.

If prices flatten or decline, a borrower might be unable to sell a house for enough to pay off such a loan.

Greenspan said such loans account for only a small fraction of all the mortgages outstanding, and therefore do not pose a threat to the overall economy.

But, he added, these mortgages in "individual cases, could prove disastrous."

The Fed chairman went on to warn lenders to "fully appreciate the risk that some households may have trouble meeting monthly payments as interest rates and the macroeconomic climate change."

Greenspan discussed the risks in the housing market while delivering an upbeat assessment of the overall economy in his semi-annual report to Congress on behalf of the Fed.

'FIRM FOOTING'

"The U.S. economy has remained on a firm footing, and inflation continues to be well contained. Moreover, the prospects are favorable for a continuation of those trends," he said.

Stock prices rose after he spoke, with many investors cheered as well by his comments reaffirming the Fed's belief that it can probably continue raising short-term interest rates at a gradual, or "measured," pace.

The value of all U.S. residential real estate rose 15 percent in the first three months of the year from a year earlier -- faster than the growth in after-tax income, according to the latest Fed data.

Greenspan said it is difficult to know whether homes are overvalued on average nationally.

But he repeated that "there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels."

The National Association of Realtors estimates that 23 percent of U.S. homes purchased last year were for investment. Another 13 percent were second homes.

When one size fits all, none are fit well

By Chuck Jaffe, MarketWatch

BOSTON (MarketWatch) -- When one size fits everyone, you can bet that most people are improperly covered.

That's because proper fit is different from something that provides coverage in a fashion that is too baggy or too tight, too long or too short, or simply odd.

The same goes for generic financial advice that is thought to apply for everyone.

While consumers and investors desperately want rules and guidelines that can take them directly to the promised land of smart personal finance, the reality is some of the most common one-sized advice actually fits few people well.

Last week, this column focused on some common savings and investing rules that people tend to follow blindly, thinking that they are sound formulas.

This week, we'll look at five more financial rules of thumb, pointing the fingers at the flaws in these common misconceptions about insurance, spending and savings. If you follow these rules, you should review your situation to see if you are the rare person these suggestions actually fit.

To retire comfortably, your investments must generate 70 percent of the income you earned while working:

This is one of the most dangerous -- and most widespread -- financial rules of thumb, because it ignores virtually all critical factors and influences.

In short, it's no better than a guess.

Your retirement income needs are a function of life expectancy, inflation, and spending, not previous salary. If your idea of retirement is foraging for nuts and berries while camping in national parks, you'll need a lot less money than if you want to cruise the world on a luxury liner.

This formula forecasts a cut in key living expenses when you are in retirement, assuming you'll have paid off the mortgage and won't have other costs associated with working.

But most people don't want to live out their remaining days with a 30 percent reduction in available spending money. For anyone who wants to avoid that kind of cut, aiming at this 70 percent target leaves them short of the standard of living they hope at achieve.

Life insurance benefits should equal five times current income:

A long-time insurance industry marketing ploy, this formula is another feel-good guess.

Buying coverage valued at five times income may be appropriate for the sole breadwinner in a family with two kids -- although the family's lifestyle determines if it's correct -- but it's completely inadequate for larger families, and it's a money-waster for anyone without children.

Anyone looking at life insurance and trying to buy sufficient protection without overspending on coverage they don't need should go through a detailed needs analysis, based on individual circumstances and the level of support necessary for the family.

Always use borrowed money to pay for your home:

With interest rates at historic lows over the last few years, this rule has become that much more ingrained in many consumers, but that still doesn't make it right for everyone.

The logic here is that you want to capture the mortgage-interest tax deduction.

While the deduction is a big help on April 15, it's not always the way to go.

Paying ahead on your mortgage -- which cuts both the amount owed and the total potential deduction -- gives you a guaranteed rate of return (equal to the mortgage rate, since you will never pay interest on money that is prepaid) for your dollars. Owning your home free and clear creates peace of mind, erasing the burden of a big monthly payment and the thought that some bank is lurking, waiting to take over in the event of a financial disaster.

In addition, with a growing number of forecasts predicting a cool-off in real estate prices in the near future, leveraging your home to the max could increase the family's vulnerability during a rough economic cycle.

Getting the tax deduction and using credit to increase your purchasing power is fine, but not at the cost of peace of mind.

Homeowner's insurance should match your purchase price or cover the cost of your mortgage:

The wicked hurricane season of South Florida last year showed just how many people fall for this outrageously dumb idea.

If you worry about the purchase price, you may be paying for excessive coverage - a fire or storm typically doesn't destroy the land on which the home sits, although the price included that property -- or leaving yourself vastly under-protected, if the mortgage is a fraction of the home's replacement cost.

The only standard that matters in these situations is that your coverage provides enough money to rebuild your home. When the policy pays replacement cost, it means that you'll get your money's worth in the event of a disaster, and that's what you have insurance for.

Keep three to six months of salary in an emergency fund:

For many people, gathering an amount equal to six months' worth of take-home pay could take a few years.

That's why determining an appropriate emergency reserve is an individual decision that takes into account everything from an individual's disability insurance coverage, available sources of credit, and ability to borrow against retirement plans, to the income level of a spouse or partner.

To set an appropriate reserve, consider the chance for a personal disaster and the potential costs you'd have in that worst-case scenario. Emergencies run the full gamut, from health problems or job loss down to car wrecks or the immediate need to replace a big-ticket household appliance.

If you are debt free, credit cards and lines of credit may suffice as emergency protection, and shorten the kind of reserves you need to build. If you have debt or fear a protracted period of unemployment, the full six-month cushion might provide peace of mind.

Most importantly, whenever your personal or financial circumstances change -- from the birth of children to being part of a corporate takeover to getting remarried, to retiring -- the way you calculate your appropriate emergency reserve changes too.

Evaluating Ways to Nix Mortgage Insurance

The Associated Press

NEW YORK -- If you're tired of making monthly payments toward private mortgage insurance, you may have an out.

While these payments are irksome for many borrowers _ they aren't tax-deductible _ they do help people buy homes they couldn't otherwise afford by allowing them to put less money down upfront. Indeed, lenders have traditionally required borrowers to pay mortgage insurance if they borrow more than 80 percent of the home's price to protect against default.

However, house prices have kept rising in many parts of the country. The median U.S. home price has risen 25 percent over the past four years; prices in some urban areas have gained even more. So now's the best time to evaluate whether that appreciation might present an opportunity to cancel your policy.

Borrowers can ask to have their private mortgage insurance canceled once they effectively own 20 percent of the house.

"Through a combination of paying (off your mortgage) and home price appreciation, you might be able to cancel the insurance within as little as two years," says Keith Gumbinger, a vice president at HSH Associates, financial publishers in Pompton Plains, N.J.

Many consumers _ notably first-time homebuyers in today's hot real-estate markets _ simply can't manage to come up with the traditional down payment of 20 percent. In fact, the median down payment for a first-time homebuyer is 3 percent, according to a survey conducted by the National Association of Realtors.

The insurance can be quite expensive. For instance, putting $30,000 down on a $350,000 home (at a fixed rate for a term of more than 25 years) translates into a loan-to-value ratio of 91.43 percent. This would require a monthly private mortgage insurance payment of $208, according to the PMI Calculator on HSH's Web site.

There are a few factors that need to be considered before ordering up a home appraisal for $350 or so.

Greg McBride, a senior financial analyst at Bankrate.com, notes that lenders often require you to keep the insurance for a certain period, typically between one and five years.

"It's important to involve the lender in this process so that borrowers don't pay for an appraisal unnecessarily," McBride says.

Naturally, borrowers must have a respectable payment history in order to qualify for a cancellation, nor can there be a second mortgage out on the home.

There are very few loans that require insurance for the entire loan term, but there are some exceptions, according to the Mortgage Insurance Companies of America, a mortgage insurance industry trade group. Some loans, such as certain low-down-payment loans through Fannie Mae, Freddie Mac and the Veterans Administration, are exempt from cancellation laws, according to MICA. And "lender paid" mortgage insurance, or when the insurance is paid by your lender, translating into a slight higher interest rate on the loan, can't be canceled during the loan's lifetime.

Meanwhile, the Homeowners Protection Act of 1998 requires servicers to automatically terminate coverage on most loans originated after July 29, 1999, when the loan is paid down to 78 percent of the house's original value, MICA says on its Web site. MICA also has a calculator that estimates how long it will take to get your PMI automatically canceled.

Getting to that point can take quite a while _ often a decade or more _ which is why borrowers should factor in any home appreciation, as well as equity built up in their home, and see if they are eligible sooner rather than later.