The Teaser Rates Combined With Adjustable Interest Rates Caused Borrowers To Be Hit With Huge Mortgage Payment Increases

Category: Finance, Real Estate.

Subprime lending has recently caused over 40 lenders to either go out of business or stop issuing subprime loans because of excessive foreclosure rates.

The housing demand was so strong that lenders started to compete for the insatiable mortgage demand by making qualifying very easy. The lending community made decisions in the last few years that dramatically eased a borrower s qualifications with a resultant dramatic increase in foreclosures. One example was the creation of the" stated income" loan, or the" liar s loan" . Unfortunately about 60% of borrowers over- stated their income on their loan applications to qualify for their loans. In the loan application, the borrower only had to" state" his income without showing any proof of that that income. A review of lending practices showed racial disparities in African- American and Hispanic low- income neighborhoods which had 1 � times as many subprime loans at higher interest rates and closing costs as compared to low- income white neighborhoods. But to make payments as low as possible for the borrowers, lenders developed low- initial interest rate loans( teaser rates) or negative amortization( Neg Am) mortgages.

The lenders planned to compensate for higher default rates by charging higher interest rates and closing costs. With a Neg Am loan, a borrower would actually owe more than he originally borrowed when he went to sell. Most borrowers couldn t afford huge monthly payment increases and foreclosure rates began to rise. The teaser rates combined with adjustable interest rates caused borrowers to be hit with huge mortgage payment increases. Lenders gave the loans on the assumption that the homeowner would do whatever necessary to make the payments, or the lender would get the property back in foreclosure and re- sell it for a profit in" hot real estate" markets. The actual statistics went from investors owning about 2% of all single family homes in 1990 to almost 28% in 200This huge increase in investor ownership caused the" tail to wag the dog" and sent the real estate market into price advances that exceeded historical stock market gains. Overlooked by lenders was the fact that real estate investors had become a major factor in the real estate market that had previously been dominated by the" retail buyers" or single family homeowners.

Lenders were not discouraged, and to make loans even more affordable, developed 100% financing loans designed to eliminate" PMI" or Principal Mortgage Insurance by using an 80% first and a 20% second mortgage. We are now seeing huge default rates among 80/ 20 financings because the borrowers saw an opportunity to refinance their properties, cash out an equity profit without having to sell their homes, and just walk away without making any mortgage payments. This 80/ 20 program was so successful that it became the standard loan for most new homeowners for an 18 month period in 2003- 200Now the borrower had two mortgages, the first at a traditional interest depending on the borrower s credit rating and a second mortgage with a higher interest rate of 3% to 5% above the first mortgage rate. Who are the losers? There are solutions, but barring governmental intervention, the average homeowner needs to focus his financial future on getting a fixed rate mortgage. Unfortunately, anyone with an adjustable rate mortgage who can t convert it to a fixed rate, investors who own mortgaged properties, new homeowners with challenged credit or minimal down payments, the support personnel for the real estate industry, including realtors� , construction personnel, mortgage brokers and, construction support industries their staffs, lenders and their staffs, attorneys who specialize in real estate law, surveyors, appraisers, home inspection personnel, and just about anyone in a support industry related to real estate. Trimming his expenses where possible.

Be proactive in selling his home and slow to replace it with another home. Taking advantage of his property tax exemptions for homestead, or senior discounts, military service. Stay away from" funny money" loans that could escalate sharply. As bleak as the future appears for many economists, the financial markets have weathered worse financial storms. And save cash for a larger down- payment to reduce his interest rate and monthly payments. I suspect the final solution will take years and need the banking industry to become more pro- active is the resolution of the individual homeowner s financial problem.

An alternative solution involves the lending institutions developing a strategy of better handling of the re- sale of the bank owner properties by offering them directly to new homeowners by a national bidding system, involving all the lenders.

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