Foreclosures will rise over the next few years, experts
agree. While each foreclosure is traumatic for the family that loses
a house, the coming wave of defaults won't swamp the system.
The borrowers in the most danger
have two strikes against them. First, they are
(or will be) under water -- owing more than the
house is worth. Second, they have adjustable-rate
mortgages, or ARMs, with low "teaser rates."
Eventually, after anywhere from one month to five
years, the ARM enters its rate-adjustment period
and the loan is reset with a higher rate. Use
Bankrate's helpful Mortgage
reset calculator to find out what your own
ARM rate could be after it is reset to a new rate.
Quite a few homeowners have these two strikes, and
almost $200 billion in foreclosures will result, says Christopher
Cagan, director of research and analytics for First American Real
Cagan prepared a 32-page report (PDF) in February that measured the extent of the risk to the mortgage
market. It's not a financial-planning guide, but here's what consumers
can take away from it: If you have an ARM with a teaser rate of
2.5 percent or less, watch out -- because the monthly payments could
skyrocket -- even double -- after the rate is reset.
And if, in addition, you owe more than the house is worth, you could
find yourself in serious trouble -- unable to refinance and unable
to sell without a loss.
Pretty common-sensical, really. That's why Larry Goldstone isn't all that worried.
'People are good people'
Goldstone, president of Thornburg Mortgage, based in Santa Fe, N.M.,
says, "Generally speaking, I think people are good people.
They borrow money with the intention of paying it back."
When the business cycle moves down and people lose
their jobs, more of them default, Goldstone says. It doesn't matter
much if the borrower gets a 30-year, fixed-rate mortgage or something
nontraditional, such as a payment-option ARM, in which the minimum
payment doesn't even cover that month's interest.
David Greco, vice president of credit policy for MGIC, the largest insurer of
mortgages, agrees that the loan type doesn't matter much. A precarious mortgage,
he says, is one "where the likelihood that they'll be able to repay it is
low, and I don't think there is anything that is inherently risky about any loan
programs that are out there today."
The risk comes from the possibility that the borrower
and lender didn't accurately assess the borrower's ability to repay, Greco says.
One person might be able to handle a payment-option ARM with aplomb, while another
person might wilt under a 30-year fixed.
That's not exactly how the federal government sees
it. Regulators have proposed guidance -- essentially, a set of strong suggestions -- urging lenders to
be more careful with interest-only and payment-option ARMs, especially
in cases where the homeowner has little or no equity in the house
or when the borrower produced little or no documentation of income
are also concerned that these products and practices are being offered to a wider
spectrum of borrowers, including some who may not otherwise qualify for traditional
fixed-rate or other adjustable-rate mortgage loans, and who may not fully understand
the associated risks," the proposed guidance says.
Bankers worry that the guidance could result in fewer
loans to deserving home buyers. "The question is, without these
products, would we be better off? The answer is no," says David
Herpers, chief marketing officer for Amerisave, a lender that specializes
in customers with damaged credit. "I think, as a consumer,
these emerging mortgage products are, overall, extremely beneficial."
Anthony LaGiglia, a financial planner with J.J. Burns
& Co. in Melville, N.Y., isn't as sanguine about nontraditional mortgages.
"When you look at interest-only mortgages, they were for a very select group
of people -- a business owner or a Wall Street person who gets a huge bonus every
year," he says. "But they're becoming more commonplace. A lot of people
are utilizing them just to afford a house. A lot of people are getting in over