The Foreclosure Report

Study Questions Lending Industry Claims

Kenneth Harney writes at the Washington Post. "They are the new breed of mortgages, and home buyers in high-cost real estate markets can't get enough of them: interest-only and payment-option plans that cut monthly payments sharply in the early years of a loan."

"Lenders have marketed both types of mortgages aggressively, often to people who need to stretch their incomes to afford homes, but have said often that their borrowers have solid credit histories and excellent credit scores and that they fully understand the risks once payments reset in a few years."

"A new statistical study challenges some of the mortgage industry's claims about borrowers' sterling credit qualities. The Consumer Federation of America examined the case files of more than 100,000 mortgages closed from January to October 2005. Among the findings: Home buyers who take out payment-option loans tend to have below-average credit scores. Nearly 54 percent of payment-option users in the sample had FICO scores below 700."

"Most payment-option mortgages permit borrowers to choose what they want to pay per month for a preset period. Some mortgage securities industry experts estimate that up to 70 percent of payment-option borrowers go with the minimum payment. That, in turn, causes them to increase their principal debt through a process known as negative amortization."

"Borrowers often are allowed to increase their original loan balance by 10 percent to 25 percent before they must begin paying down the principal with significantly higher monthly payments."

"The Consumer Federation study also examined the household incomes of interest-only and payment-option borrowers. More than three in five payment-option plan borrowers and 47 percent of interest-only borrowers had annual household earnings of at least $72,000, seemingly a good sign."

"But Patrick Woodall, co-author of the study, noted that many of those households still had incomes well below the median for their metropolitan areas, which often are high-income, high-cost markets such as Washington, San Diego, Los Angeles and San Francisco."

"More troubling, he said, was the finding that many borrowers using interest-only and payment-option loans have modest incomes and could already be stretched financially. One in eight payment-option borrowers and one in six interest-only borrowers earned less than $48,000. Woodall said that 'all sorts of events could trigger problems for these people' that could lead to defaults, foreclosures and loss of houses."

"Though the jury is still out on the risks of payment-option and interest-only mortgages, the Consumer Federation's findings suggest that lenders are hardly reserving them for high-income, high-credit-score applicants. In an economic squeeze, some of the loans could prove highly toxic, a prospect almost certain to weigh heavily in the financial regulators' forthcoming new guidelines."

posted by Ben Jones @ 2:23 PM