Creative mortgages fuel home sales
By Ruth Simon
The Wall Street Journal
Originally published March 22, 2004NEW YORK -- With home prices surging, lenders are devising increasingly creative mortgages aimed at homeowners whose budgets are stretched thin.
Among the newly popular options: loans based on the value of the home after improvements are made; "piggyback" loans that combine a standard first mortgage with a home-equity line of credit.
And such lenders as Countrywide Financial Corp. are offering mortgages that allow some borrowers to skip up to 10 payments over the life of the loan.
Higher home prices spur creativity
The rise of these oddball mortgages comes as sky-high home prices are making it tougher for many borrowers to afford their dream house -- or any house.
Median home prices climbed 7.5 percent last year, the biggest increase since 1980, according to the National Association of Realtors in Washington. And they're expected to climb nearly as much this year overall. Some markets on the East and West coasts have seen annual double-digit increases since at least 2000, and could see them again this year.
In California, fewer than one in four households now can afford the median-price house using a conventional 30-year fixed-rate mortgage, according to the California Association of Realtors.
In the Baltimore region, the average selling price of homes rose 6.5 percent last month to $202,208, according to the Metropolitan Regional Information Systems Inc. in Rockville. Sales of existing homes in Baltimore and its five surrounding counties increased to 2,492 last month, 14.94 percent more than in February last year, MRIS said.
Nonconventional mortgages and looser lending standards make homes more affordable at a time when prices are soaring. But they also contribute to the rise in prices by making it possible for more people to buy their first home -- or trade up to something nicer.
These loans "help create the inflation in values," says Kenneth Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California at Berkeley.
'Niche' mortgages
While most home buyers still opt for traditional fixed-rate loans, lenders are planning to introduce an even wider array of niche mortgages as the refinancing boom wanes and competition intensifies.
Countrywide, for instance, is looking into a mortgage that would allow buyers of new homes to finance not only the purchase price, but also their utility bills. IndyMac Bancorp, meanwhile, is rolling out a mortgage aimed at self-employed borrowers who have most of their assets tied up in their own business and little cash.
But flexibility has a price. For example, if you take out a loan that lets you skip some mortgage payments, you'll pay more in interest overall. That's because the missed payments are tacked on the back end of the loan.
With rising prices forcing many buyers to settle for homes that need work, such lenders as Wells Fargo and GMAC Mortgage, a unit of General Motors Corp., also are pushing "purchase-and-renovate" loans. These allow the borrower to finance the cost of the home plus remodeling expenses based on the home's value after improvements are made.
Because these purchase-and-renovate loans are riskier than conventional mortgages, however, rates are typically one-eighth to one-quarter of a percentage point higher. In addition, borrowers often pay interest on the total value of the loan, even though they won't receive money earmarked for renovation until improvements are made.
And, the lender must approve the building plans.
'The house of my dreams'
Already, some loans that seemed novel just a year or two ago have become almost mainstream. One example: interest-only mortgages, which allow borrowers to pay interest and no principal in the early years of the loan.
Lee Silverman, a life-insurance salesman in Scottsdale, Ariz., recently locked in a $496,000 interest-only mortgage that carries a 4.875 percent rate for the first 10 years.
"It allows me to get the house of my dreams at the most reasonable cost," Silverman said. His monthly payments will total $2,014, or roughly $600 less than he would pay without the interest-only feature. At State Mortgage in Phoenix, where Silverman got his loan, interest-only mortgages are second only to 30-year fixed-rate loans in popularity.
But like many of these niche products, interest-only loans have their drawbacks. Borrowers don't build up any equity during the interest-only period, which can be as long as 15 years. As a result, if home prices fall, borrowers can wind up owing more than their home is worth.
'Piggyback loans'
Frothy home prices also have boosted the popularity of "piggyback loans," which combine a standard first mortgage with a home-equity loan or line of credit. Piggyback loans were first used to get around private mortgage insurance, which is required when borrowers take out a mortgage that exceeds 80 percent of the purchase price.
But they have also found favor with borrowers trying to avoid paying the higher rates charged for jumbo loans, currently any mortgage above $333,700. Someone borrowing $400,000, for example, might take out a mortgage for $325,000 and a $75,000 home-equity line of credit. One risk: If short-term rates climb, borrowers with lines of credit will face higher payments.
At GMAC Mortgage, about 20 percent of borrowers who take out a fixed-rate mortgage use a piggyback loan to avoid private mortgage insurance or the higher costs of jumbo loans. When piggyback loans first were introduced a decade ago, most borrowers put down 10 percent, then took out an 80 percent mortgage and a 10 percent line of credit.
But as home prices have surged, more buyers are opting for 80 percent mortgage and a 20 percent loan or line of credit -- effectively buying a house with no money down.
Bringing back some products
Lenders also are retooling products that fell out of favor years ago. One example: so-called negative amortization payment options that let cash-strapped borrowers cut their payments to the bone. They work by letting consumers make a minimum payment based on interest rates at the start of the year.
The downside of these loans: If rates rise, borrowers can wind up owing more than when they started.
Negative amortization loans got a bad name in the 1980s, when interest rates soared, and some borrowers walked away from their loans. But they have resurfaced in the past year in short-term adjustable-rate mortgages that let borrowers choose one of four payment options each month. One option is a minimum payment that can lead to negative amortization.
But lenders say they have tightened their lending standards and now do a better job of explaining the loan's risks, and the loans have resurfaced lately, with consumers lured by initial interest rates that can be as low as 1.25 percent. At IndyMac, roughly one in five borrowers locking in a mortgage rate through the bank's brokers is opting for FlexPay loans that carry the negative-amortization feature. Washington Mutual Inc. says sales of a similar product climbed 83 percent in the fourth quarter.
As lenders look for new niches, even borrowers who worry about missing a payment have a loan that's tailored to their needs. Some lenders let borrowers skip up to two payments a year, or 10 payments over the life of the loan, without ruining their credit rating.
But such loans aren't cheap.
At Countrywide, for instance, borrowers who select the skip-a-payment loan can elect to pay an upfront charge or an extra $100 to $230 each time they miss a payment.
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