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Letter to the editor

New rage in mortgages is a roll of the dice

By ROBERT TRIGAUX
Published June 6, 2005

Pssst ... Want to cut your mortgage payment almost in half?

What home buyer already stretched by area housing prices would not jump at that offer?

Soaring real estate prices that astound even veteran mortgage lenders are driving more home buyers and investors to embrace a type of loan that barely existed a few years ago. Called "interest-only" mortgages, these loans can cut a typical $1,200 monthly payment on a 30-year, fixed-rate loan to nearly $600, at least for a while.

An interest-only mortgage lets borrowers pay only the interest, typically for the first five years. The required monthly mortgage payment includes no repayment of principal.

There's just one little problem. These mortgages are higher-risk loans. Borrowers using them are betting that their homes will continue to appreciate enough to cover the loans' higher payback costs down the road.

That type of pay-a-lot-less-now loan is a siren's song to cash-stressed buyers scrambling for ways to afford almost-out-of-reach homes. How else, borrowers say, can they afford the house they want and still have money left from paychecks to cover other expenses?

So alluring are interest-only loans, they now make up close to 20 percent of mortgages loaned nationwide and in the Tampa Bay area. Just four years ago, these loans made up less than 2 percent of the mortgage market, according to LoanPerformance Inc. of San Francisco.

That's an astonishing gain in so little time in such a huge mortgage market.

"People see the low monthly payment, and that is all they care about," said a concerned Donnell Smith, executive vice president of Market Street Mortgage in Clearwater. "I think the interest-only loan is a great product for the right buyer, such as the wealthy investor. But it is not great for first-time home buyers, and they are taking these loans right and left (combined) with no down payment. I do not understand it."

In other parts of Florida, the boom in interest-only mortgages is even more intense. In Fort Lauderdale, a third of home buyers used interest-only mortgages last year, while 6.7 percent used them in 2001. In Panama City, 60 percent of home buyers chose interest-only loans in 2004, up from just 5 percent in 2001.

And in what may be Florida's most speculative area for real estate investing - Fort Walton Beach, located between Pensacola and Panama City - 71 percent of mortgage borrowers tapped interest-only loans in 2004. In 2001, only 1.9 percent chose them.

That's the highest percentage of interest-only loans in any market nationwide tracked by LoanPerformance.

In contrast, low-appreciating markets in parts of Pennsylvania, Ohio and Michigan continue to use few interest-only mortgages.

In Florida's hot housing world, the rise of interest-only loans reflects a gotta-have-it-now attitude among buyers.

Young adults are worried that if they do not buy a house soon, what is now merely overpriced will later be unattainable. Investors see real estate as the best place to leverage their money at a time when the stock market is treading water. Speculators embrace interest-only loans as the cheapest way to buy a home or condominium, then sell it, often before construction begins.

Some economists even warn that real estate is becoming so expensive because interest-only loans are proliferating, adding an almost Vegas-style style of gambling to the national house and condo markets.

About 85 percent of interest-only loans are refinanced within four years, before higher loan payments kick in. But if mortgage rates rise significantly in that period, or housing prices decline, refinancing may not offer much, if any, relief.

That unpleasant scenario has not materialized yet. Most interest-only loans are still too new to gauge their impact on the housing market.

Florida's single-family home prices seem unlikely to dip soon. But nothing lasts forever.

Last week, the Office of Federal Housing Enterprise Oversight updated its quarterly analysis of U.S. housing prices and hinted that some markets are looking vulnerable.

The agency's housing index "shows the rise in house prices continues at an extremely strong pace and raises the potential for declines in some areas later on," said agency chief economist Patrick Lawler.

Four of the nation's 20 fastest appreciating metro markets are in Florida. That includes three markets on the east coast and the nearby Sarasota-Bradenton area.

Despite multiple attempts by the Federal Reserve to raise interest rates, mortgage rates are not following the Fed's lead. The rate on the average 30-year, fixed-rate mortgage nationally fell to 5.62 percent last week, well below the 6.32 percent level of a year ago.

Interest-only mortgages are not the only alternative to fixed-rate mortgages. Adjustable-rate mortgages, called ARMs, also are increasingly popular options because they offer low rates to start.

Combined, ARMs and interest-only mortgages accounted for 63 percent of mortgages originated in the second half of last year, according to the Mortgage Bankers Association.

The rapid adoption of interest-only loans recently caught the attention of federal bank regulators wary of sloppy lending habits. Regulators issued rules tightening how banks offer home equity lines of credit. Some experts see tougher credit standards ahead for interest-only loans.

John Mudd, who sells homes and condos along the Pinellas County beaches for Exit Realty Suncoast, considers the interest-only mortgage "the most popular one for first-time buyers, primarily because it makes payments the most affordable for the first five years." Most first-timers expect to buy something else within the next five years, he said.

Interest-only loans sure stimulate home sales. But will they stimulate foreclosures later?

Jack Guttentag, professor of finance emeritus at the University of Pennsylvania's Wharton School, offers a reminder that there's little really new under the sun. Even in home financing.

"Interest-only mortgages were the standard mortgage in the 1920s, but they disappeared during the Great Depression, and for good reason," Guttentag wrote last month on Bankrate.com.

Well, the new and improved interest-only mortgage is back and looks likely to prosper as long as the super-heated housing markets burn bright.

--Robert Trigaux can be reached at 727 893-8405 or trigaux@sptimes.com

[Last modified June 6, 2005, 01:34:12]