Millennials who watched their parents or grandparents struggle with toxic mortgages, short sales and foreclosure might be reluctant to buy a home and get a mortgage themselves. But in fact, most of those bad old loans are gone and while real estate is never risk-free, today’s traditional terms, strict guidelines and government-mandated forms can help millennials become safe and successful homeowners.
The differences are dramatic, says Greg Cook, senior loan officer for Platinum Home Mortgage in Temecula, California.
“If we go back 10 years, there were so many loan programs and most of them were, pardon my French, crap,” Cook says. “Loans today are almost identical to when (millennials’) parents bought their 1st home.”
One of the riskiest old loans was known as the payment-option mortgage because it gave borrowers a choice of 4 monthly payments: a minimum payment, interest-only payment or 15-year and 30-year full amortizing payment, Cook explains.
“It was a problem because almost everybody took the path of least resistance and said, ‘Let’s make the minimum payment.’ As a result, the loan balance got bigger.”
This increase in the loan balance is known as negative amortization or, more commonly in the shortened form, “neg am.”
When house prices depreciated, borrowers found themselves upside-down, owing more than their homes were worth. Many stopped paying and let banks foreclose.
Today, neg am loans are exceptionally rare, if they can be found at all, because of a federal regulation that grew from the housing crash: the qualified mortgage rule.
Lenders get special protections when they make qualified mortgages — and qualified mortgages must be fully amortizing, which means the payment must include enough interest and principal to pay off the loan over the term. Negative amortization isn’t allowed.
Interest-only loans, sometimes written as I/O, allow borrowers to make payments that include interest, but not principal. When the borrower makes the minimum payment, the loan balance doesn’t increase, but it doesn’t decrease either.
Where many borrowers “went sideways,” to use Cook’s words, with this type of loan is that after a specified number of years, the loan typically is recast and the borrower has to make principal and interest payments to pay it off, but over a shorter term.
That results in a much larger monthly payment that caught many borrowers by surprise.
“People weren’t prepared for the bump,” Cook says.
Michelle Velez, a mortgage sales manager in San Mateo, California, says some interest-only loans are available today. They typically require the borrower to qualify based on the fully amortized payment instead of the interest-only payment.
“They have to have more capacity to pay,” Velez says.
Lenders typically require borrowers to pay for an appraisal of the home they want to buy to confirm that the home’s value supports the purchase price.
If the appraisal is “low,” the lender might not approve the borrower’s loan and then the deal might fall through, leaving the mortgage broker and realty agents without their commission checks.
Before the 2008 financial crisis and subsequent government regulations and changes in the real estate business, brokers and agents could pressure appraisers to make sure valuations were never “low,” regardless of the homes’ true values.
“They were coercing the appraiser and saying, ‘If you can’t bring it in at this value, I’m not going to give you my business,'” Velez says. “Not everybody did that. But there were people doing 20, 30 loans a month, and if they were ordering all their appraisals with one appraiser, that was a big chunk of income that the appraiser would lose.”
Today, appraisers are kept at a professional distance from brokers and agents to help protect them from this type of undue influence.
“The person buying the house is getting a more accurate reflection of the value,” Cook says.
Given this sorry history of payment-option and interest-only loans and inflated incomes and appraisals, it’s no wonder millennials want home mortgages that are safe and predictable.
Millennials “grew up in a shadow” of parents who lost a job, struggled with a mortgage and maybe lost a home, says Fred Kreger, certified mortgage consultant for American Family Funding, a mortgage company in Santa Clarita, California.
“In the back of their mind, sometimes they think mortgages are evil,” Kreger says.
This, too, could be changing due in part to the new Loan Estimate and Closing Disclosure forms designed, consumer-tested and, as of Oct. 3, 2015, mandated by the federal government. Read Bankrate’s guide to the Loan Estimate.
The Loan Estimate form, Kreger says, “clearly explains everything (borrowers) are getting into, as opposed to in the past when they weren’t necessarily explained to upfront.”
A last word about the form, from Kreger to millennials, is: Read it.