Homebuyers are turning to riskier loans as interest rates rise

WASHINGTON – Home buyers feeling financially stressed by rising interest rates are increasingly being directed by real estate agents and mortgage brokers into potentially riskier types of mortgages, similar to those seen before the 2008 financial crisis, causing concern. Some consumer advocates and industry analysts.

Among the loans promoted for home buyers are adjustable rate mortgages, called 2-1 purchases, which artificially lower rates for the first two years, and interest-only mortgages in which borrowers make a lower monthly payment for several years by Payment only. The interest on the loan, according to interviews with real estate professionals, industry data and a review of marketing materials from real estate agents and mortgage brokers.

In all cases, borrowers can find themselves receiving monthly payments in excess of hundreds of dollars a month after the introductory period, a dynamic seen in the run-up to the recent housing market crash when predatory lending led to millions of borrowers losing their homes and forcing some major financial institutions out of business. .

Industry experts say they don’t expect the US to see a repeat of the recent mortgage crisis due to regulations that have since been put in place, and higher standards in terms of who qualifies for a mortgage. They also note that adjustable mortgages and other atypical home loans make up a much smaller percentage of total mortgages than seen during the 2008 crash.

But consumer advocates and others close to the real estate industry warn that homebuyers may find themselves in a precarious financial position when mortgage interest rates are reset and their monthly payments are rising.

“We are watching with concern as we see more interest in alternative mortgage products that often include some type of initial interest rate teaser and the rate will go up,” said Sarah Mancini, employee attorney with national consumer law. center. “The scary thing about this market is that people are trying to stretch to get in the door and that can put people in a very difficult place.”

Mancini and other consumer advocates say the trend toward riskier mortgages is particularly worrisome given the general uncertainty in the economy as economists and business leaders predict unemployment will rise, interest rates will continue to rise, and housing sales will decline. These dynamics may mean that more people are out of work and unable to refinance their homes at a lower price or sell them if necessary.

Barry Zingas, a senior fellow at the Consumer Federation of America and was senior vice president of community lending at Fannie Mae from 1995 to 2006, said, “I would caution consumers to always plan for the worst, and hope for the best. But more often in these circumstances. People find themselves planning and hoping for the best, and that’s not a good recipe for success.”

Rates for a standard 30-year fixed-rate mortgage have doubled since the beginning of the year, meaning the monthly payment for a $400,000 mortgage now costs $865 more per month than it did in January.

Home prices are beginning to fall, and the trend is expected to continue, although prices should remain well above pre-pandemic levels through 2023, according to estimates by investment bank Goldman Sachs and rating agency Fitch.

Nick Holman, director of financial planning at Betterment, a bot advisor, said he’s been hearing a growing sense of urgency from clients about moving quickly to buy a home. Due to the high interest rates, many have been wondering about alternatives to a 30-year fixed-interest mortgage.

“Now, they feel like, ‘Oh my God, higher interest rates are coming, we want to jump on them, we don’t want to miss them again,'” Holman said. I feel more and more urgency rather than sitting on the sidelines to see what happens with prices.”

A sign for sale outside a building in Los Angeles in September 2022.Alison’s Dinner / Getty Images

As prices have risen, so has the number of adjustable mortgages, which can lower the interest rate by 1 to 2 percentage points, reducing hundreds of dollars in monthly payment, before resetting the market rate 3 to 10 years later. These mortgages now account for nearly 12% of all mortgages, up from about 3% a year ago, according to data from the Mortgage Bankers Association.

However, this share is much lower than it was during the period leading up to the financial crisis when it accounted for nearly a third of all mortgages. Regulations enacted after the financial crisis now require lenders to make a reasonable and good faith effort to determine a borrower’s ability to repay these types of loans at the highest monthly payment during the first five years and to provide clear disclosures and notices about the increase in payments.

“We shouldn’t have the same level of large, risky loan volumes for people who will eventually default,” said James Gaines, a research economist at Texas A&M University’s Texas Real Estate Research Center. “Lenders, regulators and the law all conspired in the hope that this kind of situation would not be allowed to arise.”

Linda McCoy, an Alabama mortgage broker and president of the National Association of Mortgage Brokers, said she’s seen a move toward less traditional mortgages as she and others work with clients who struggle to deal with higher rates.

Some of the most common atypical lending programs I’ve seen are those that require little or no money and that would allow buyers to use the down payment in cash to pay off debts and qualify for a larger mortgage. I’ve also seen the return of 2-1 purchases where a buyer, seller or lender advances the money to reduce the interest rate by 2 percentage points in the first year and 1 point in the second year.

It’s an incentive that real estate agents tout in dozens of posts on Facebook, YouTube, and TikTok, especially to sellers who resist price cuts. In marketing materials, mortgage brokers often suggest that buyers can refinance after the two-year period, indicating that rates will decrease in the near future.

But Mancini, the staff attorney, said it could be a financial predicament for some buyers who may be tempted with lower payments and assume they will see their income increase or be able to refinance before the two-year period ends. National Center for Consumer Law.

But US regulators say they are confident there will not be a repeat of the 2008 housing crash given regulations that have since been in place, and so far they are not seeing lenders soften their standards on who to give out mortgages. Mark McCardle, Assistant Director of Mortgage Markets for the Consumer Financial Protection Bureau.

“There’s not a whole lot of room to do some of the risky things that happened in 2006 that you could sell to some investors and they wouldn’t even know what they were buying,” McCardle said.

However, regulators are recognizing the changing dynamics in the housing and mortgage industry and are watching them closely, McCardle said. Banks and mortgage providers also say they have a new level of caution this time even as they press to stay in business amid the slowdown in home sales.

But even with safety nets in place, consumers still need to be aware of the risks they are taking and the assumptions they are making about what the future holds, say industry experts.

“You have to sit down and make a rigorous, rational and unemotional assessment of your circumstances, and act accordingly,” said Gaines, an economist at Texas A&M University. “Or just admit to yourself that you’re taking a big adventure and going for it.”

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