Crackdown Coming On Low Payment Mortgages
by Howard Gartenhaus

According to the Washington Post, The Nation's Housing column, December 10, 2005, much stiffer mortgage regulations beginning in 2006 will significantly rein in much of the fuel that has sent real estate values soaring in key markets over the past several years.

One of the most popular types of mortgages in these hot markets has been loans that allow for 1% to 2% payment rates leading to "negative amortization." This type of "payment option" loan has been so popular because the low payments have enabled buyers to purchase costly properties that otherwise would be unaffordable.

Payment option mortgages typically carry 30-year terms, but allow up to five years of reduced rates as one of several payment plans. The borrower can choose to make a minimum payment consisting of interest only, or fully amortizing payments, which also apply amounts to reduce the principal owed. Would it surprise you to learn that 70% of borrowers choose the minimum route?

When a buyer pays the minimum rate, the loan balance actually increases rather than decreases. The deferred principal and interest payments get applied onto the homeowner's total debt on the mortgage, creating negative amortization.

Federal regulators are now worried that borrowers may be accumulating heavy debt loads on houses with the expectation that continuing double-digit appreciation will bail them out. But, if real estate prices decline, these borrowers could face the bleak prospect of loan balances that exceed the value of their property.

Payment option plans have yet another problematic aspect. In year six, after the reduced rates expire, huge "payment shocks" are looming. In year six, if mortgage rates just stay where they are now at 6%, the monthly payment on these mortgages will increase by about 50%. If rates rise to 8%, the payment increase, which would now include payments to principal, would almost double.

Financial regulators are now worried that many thousands of borrowers might not be able to handle abruptly higher mortgage payments and will be forced to sell their property. This could have potentially huge ramifications for the real estate market.

A federal task force is expected to issue new and much tougher guidelines for banks and their mortgage subsidiaries by the end of December to rein in these risky mortgages. This will act to reduce the number of qualified buyers in high-cost markets where appreciation has been fueled, at least in part, by what boils down to irresponsible lending practices.

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