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Homebuyers need to be able to truly afford their homes

By Steve Pearlstein, Washington Post
Published March 20, 2007

Today's pop quiz involves some potentially exciting new products that mortgage bankers have come up with to make homeownership a reality for cash-strapped first-time buyers.

Here goes: Which of these products do you think makes sense?

- The "balloon mortgage," in which the borrower pays only interest for 10 years before a big lump-sum payment is due.

- The "liar loan," in which the borrower is asked merely to state his annual income, without presenting documentation.

- The "option ARM" loan, in which the borrower can pay less than the agreed-upon interest and principal payment, simply by adding to the outstanding balance of the loan.

- The "piggyback loan," in which a combination of a first and second mortgage eliminates the need for a down payment.

- The "teaser loan," which qualifies a borrower for a loan based on an artificially low initial interest rate, even though he or she doesn't have sufficient income to make the monthly payments when the interest rate is reset in two years.

- The "stretch loan," in which the borrower has to commit more than 50 percent of gross income to make the monthly payments.

- All of the above.

If you answered "all of the above," congratulations! Not only do you qualify for a job as a mortgage banker, but you may have a future as a Wall Street investment banker and a bank regulator.

No, folks, I'm not making this up. Not only has the industry embraced these "innovations," but it has begun to combine various features into a single loan and offer it to high-risk borrowers.

They are a big reason why home ownership has increased from 65 percent of households to a record 69 percent. Now they are also a major reason the subprime mortgage market is melting down, why 1.5-million Americans may lose their homes to foreclosure and why hundreds of thousands of homes could be dumped on a glutted market.

How did we get to this point?

It began years ago when Lewis Ranieri, an investment banker at the old Salomon Brothers, dreamed up the idea of buying mortgages from bank lenders, bundling them and issuing bonds with the bundles as collateral.

The monthly payments from homeowners were used to pay interest on the bonds and principal was repaid once the mortgages had been paid down or refinanced.

Thanks to Ranieri and his successors, almost anyone can originate a mortgage loan - not just banks and big mortgage lenders, but any mortgage broker with a Web site and a phone. And because the originators make their money from fees and from selling the loans, they don't have much at risk if borrowers can't keep up with their payments.

What we have here is a failure of common sense. With occasional exceptions, bankers shouldn't make - or be allowed to make - mortgage loans that require no money down and no documentation of income to people who won't be able to afford the monthly payments if interest rates rise, house prices fall or the roof springs a leak.

It's not a whole lot more complicated than that.

[Last modified March 19, 2007, 23:38:31]