The Housing Mess: What Happened?
December 14, 2007
In order to understand the housing and mortgage mess of today, one must first understand what happened in the past. Starting in around 2000 and lasting up through most of 2005, interest rates were low and the value on most homes was high.
These conditions brought on a renewed interest in consumers to own homes. As this demand increased, many lenders began to promote NTM’s. NTM stands Non-Traditional Mortgage.
Non-traditional mortgages can vary and some of them are truly creative but, in general, they are often characterized by very low monthly payments during the first part of the loan term, followed by an increase in payments later on that is often not well explained to the buyer.
There was also the creative use of what are known as hybrid adjustable rate mortgages. These mortgages usually have a very low fixed interest rate for the first couple of years, usually no more than three years tops, which at the end of that time, increase substantially.
In some cases, homeowners who have these types of hybrid ARM’s will see their monthly payment increase by 30 percent or more once the rates begin to reset.
Some of the more common types of creative loans that were promoted by lenders and home builders include:
Interest-only loans are those loans where the borrower pays only the interest for the first three to five years. At the end of that time he must either pay the loan off entirely or begin paying much higher payments to repay the principal.
Another type of creative loan is the so-called payment option adjustable rate mortgage. With these types of loans, the borrower has several options on how much to pay from one month to the next for a preset time period.
For some people whose monthly income normally fluctuates, this may be a good choice in mortgages, but for most people who have a steady income, the choice can be poor. This is especially true if they begin to defer too much interest by making low payments in the early years. In essence, they end up paying interest on a higher loan amount and that can remain for many years to come.
For many consumers these loans can result in unaffordable monthly payments as the deferred principal becomes due and higher interest rates apply.
As to how the current housing market got this way, a huge number of borrowers bought into these NTM’s or hybrid ARM’s in order to buy homes they otherwise could not afford.
There is some evidence that many of these consumers simply did not fully understood the risks and the costs of these types of mortgages, and the mortgage lenders did not correctly evaluate the borrower’s future ability to make the higher payments that would be a matter of course.
In order to generate as business as possible, many mortgage lenders provided NTM’s and hybrid ARM’s to sub-prime borrowers, hoping that the rise in real estate values would continue. This rise would protect the lenders should the sub-prime borrower default on the loan.
Well, that did not happen.
Beginning in 2006, home values began to level out in many areas and they began to fall in many other areas. By this time, the interest rates on NTM’s and hybrid ARM’s began to reset to the higher rates and homeowners were now faced with substantially higher monthly payments.
For many of them, the new payment was too much to pay. Some homeowners who had once planned to refinance to lower rates began to find that option closed to them because of the overall declining market.
With much higher payments for those sub-prime borrowers becoming due, many of them began to miss payments altogether and that has them at high risk of losing their homes.
In response to this, most reputable lenders have already begun to tighten their credit standards for all borrowers. Rather than trying to create a loan to fit the borrower, they are going back to basics and finding borrowers who are qualified for the more traditional types of mortgages.
Today, they want to see home buying applicants who have good credit records, along with a reasonable down payment. They are also doing more due diligence in examining income to repay the loan.
Even with the changes that are taking place, there are still several million home loans that are schedule to reset this year and next. Once that happens, if nothing is done in the meantime to assist these homeowners, defaults on these loans could skyrocket.
While many believe that we are now in the hard time, the truth is things will get much worse once these resets begin to kick in.
Homeowners who have these resets facing them may want to consider working hard to find new financing to more traditional types of mortgages that offer fixed rates. Many lenders who are hoping to stave off a flood of defaults have decided to work with their customers as they can. This is at least one positive sign