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RISMEDIA, Dec. 9 — First-time homeowners who purchased a home during the housing boom of the past few years may find it difficult to manage their monthly mortgage payments in the near future.
Certain types of higher-risk or "exotic" mortgages that have exploded in popularity among first-time buyers are scheduled to reset to new interest rates for many families between now and 2007. This will result in monthly payments rising significantly for many homeowners.
"While exotic mortgages made the dream of homeownership a reality for many families, they can also turn into a real nightmare without much warning," says Stella Adams, executive director of the North Carolina Fair Housing Center (NCFHC) and a national housing advocate for minority, lower income, and first- time home buyers. "If you're shopping around for the lowest monthly payment and all you can afford is one of these exotic loans, then homeownership might not be a good idea just yet."
In April 2005, Adams testified before the U.S. Congress about abusive mortgage lending, offering legislative suggestions to ensure lower income and first-time home buyers are not misguided into predatory home financing.
Studies show that approximately $1.5 trillion worth of mortgages are scheduled to reset by 2007, which even at today's interest rates would cause monthly mortgage payments to increase for millions of new homeowners who took advantage of historically low interest rates offered over the past few years.
The North Carolina Fair Housing Center released a chart today entitled, "What do Interest Rates Mean for My Mortgage?" which shows how monthly payments on some mortgage products can rise sharply with even a moderate increase in interest rates. NCFHC provides this chart so that mortgage lenders, real estate professionals and the media can share this information with consumers to raise awareness about various mortgage risks.
These risks are due primarily to the overwhelming popularity of these high-risk mortgages, often called "exotic loans," that pair low monthly payments with a low down payment at the expense of a long-term fixed interest rate.
Instead, these "exotic" mortgages feature an appealing interest rate lower than an average 30-year fixed rate mortgage for a short introductory period, most commonly five years but sometimes as few as one. And, these low interest rates are not always fixed during the introductory period and may adjust as interest rates fluctuate.
High-risk mortgages come in different forms. An Adjustable Rate Mortgage (ARM) features an initial low interest rate that fluctuates as interest rates rise. ARMs are a very popular form of second mortgage used on a combo or "piggyback" mortgage. Piggybacks combine a large traditional 80 percent loan with a smaller, but higher interest rate, second mortgage so that the buyer can avoid a large down payment.
"Piggybacks have been promoted by many lenders as a way to avoid private mortgage insurance," said Adams, "but there's no way out of an adjustable second mortgage since it must be paid-off in full."
Another popular exotic mortgage is the Interest-Only (I/O) loan, which allows homeowners to pay only interest on the principal and therefore a smaller monthly payment. Most I/Os feature a low fixed interest rate for a period of one, three or five years.
The risk, according to many experts, with an I/O involves zero equity. Since none of the monthly payment goes toward paying the principal loan, the homeowner owes 100 percent of the mortgage at the end of the fixed rate period.
"Should the real estate market continue to cool as it has been, homeowners with an I/O might end up owing the bank more than their house is worth," Adams warns. "This could make it impossible to sell and create a financial sinkhole for homeowners."
While the pitfalls of these risky mortgages have been a hot topic recently, Adams says there needs to be a greater focus on solutions, so that current homeowners know their options and those looking to buy who cannot afford an unexpected increase in their monthly mortgage payment avoid these types of mortgages.
"These loans might be suitable for a small population of homebuyers who are financially prepared to manage a more expensive mortgage payment, but it is startling that so many buyers -- particularly first time buyers who have no experience with financing a home -- are turning to these loans because they offer a short term low monthly payment," continued Adams. "Fixed rate mortgages are the safest and most secure way to finance a home," she said.
"A 30-year fixed rate mortgage is available with a low down payment and no second mortgage when mortgage insurance is used to secure the loan," Adams explains. "Mortgage insurance has a bad reputation for no real reason, but it will pale in comparison to the reputation of these exotic mortgages in a few years."
Mortgage insurance can help lower income families with imperfect credit purchase a home with as little as three percent down, and it avoids the need for a piggyback loan. Additionally, mortgage insurance can be cancelled once 20 percent equity is earned through payments on principal or through home value appreciation.
"Given what's happening with interest rates and the real estate market today, a fixed rate loan with mortgage insurance is a secure option that more people should consider," Adams concluded. |
