Lenders, Regulators Spar Over Creative Home Loan Financing Options, Risks To Buyers

An important debate is raging inside the Florida home loan market, as well as around the country. Only it is beyond the earshot of most consumers.

The issue is the popular, but risky home loan options available today. In particular, the payment-option, interest-only and piggyback loans that have surged in popularity in recent years and pose a litany of financial risks to both buyers and lenders.

Federal regulators say the risks are too significant to ignore, and that as a result, lenders need to take special care in evaluating and approving customers who apply for these mortgages, writes syndicated columnist Kenneth Harney in the Detroit Free Press. Regulators want to impose new credit restrictions and disclosure requirements so that lenders will be forced to make certain borrowers aware of the potential dangers.

Banks and mortgage companies, however, aren’t happy with the regulators’ efforts. They say new restrictions are unnecessary intrusions that could undermine free-market innovations and hamper consumers’ ability to afford today’s high housing prices. In the past three months, lenders have been bombarding federal banking regulators with demands to back off or soften the proposed rules. Regulators at the Federal Reserve, FDIC and other agencies are studying the lenders’ comments and will announce final plans within the next couple of months.

So, what’s the big deal? More importantly, what might it mean for you as a home buyer or refinancer?

The bottom line is that payment-option, piggyback, interest-only and other exotic concepts can become extremely problematic for applicants who don’t understand them. The question is whether lenders are taking pains to educate borrowers about how the loans work, or whether they have been mass-marketing dangerous home loans to people with borderline credit profiles, low down payments and minimal knowledge. Below is a quick overview of some of the “exotic” options:

PAYMENT-OPTION MORTGAGES have soared in popularity in areas of the country where real estate prices and appreciation rates have been high, such as the South Florida housing market. These plans allow borrowers to choose among one of four payments each month:

1. A minimum payment based on an artificially low start rate and negative amortization.
2. A payment based on a normal, 15-year fixed-rate schedule.
3. A payment based on a normal, 30-year fixed-rate schedule.
4. An interest-only payment involving no principal reduction or amortizing payments based on 15-year or 30-year schedules.

You may not know it, but negative amortization can add 15 percent to a homebuyer’s debt in the early years of the Florida home loan and result in monthly payment increases of 100 percent or more after the loan resets. The payment shock could be far worse — well over 150 percent per month after the reset — if interest rates in the economy rise during the early years of the mortgage.

If borrowers encounter income problems or property values flatten, they might face defaults, forced sales and foreclosures.

INTEREST-ONLY Florida home loans cut monthly payments for periods from 3-10 years by deferring principal reductions, meaning that at the end of the interest-only period, the original mortgage balance on the house still needs to be paid. As a result, with interest-only loans, monthly payments can jump substantially as the principal has to be paid over a shortened time period.

PIGGYBACK LOANS are designed to combine a standard first mortgage equal to 80 percent of the property value with a home equity credit line or second mortgage equal to 10-20 percent of the home value. This has become popular because buyers can avoid monthly mortgage insurance premiums, which are mandated if your down payment is less than 20 percent of the purchase price. The piggyback loan requires little or nothing down, and qualifies jumbo loan borrowers to pay conventional market rates on the primary loan.

Banks and mortgage lenders say they select customers carefully already so as to avoid undue risks for these loans. The Mortgage Bankers Association said its members limit option and interest-only loans to people with higher credit scores and who can make a larger down payment. Lenders also sometimes argue that payment-option and interest-only loans go to relatively sophisticated people who plan to invest the money they save through the minimal monthly payments.

Nick Nickerson, a mortgage consultant with Nations Home Funding in Durham, N.C., said that 100 percent of his clients “invest their savings… and end up financially ahead. I insist that each client have a financial planner involved and the mortgage payment savings are direct-deposited to their investment account. Lenders don’t want borrowers to default. Negative amortization is simply a way of taking equity out of your home slowly over time rather than all at once.”

What it comes down to is rather simple. If you thoroughly understand all the working parts of a payment-option loan, have a great credit history, have the ability make a big down payment and a plan to use your savings like this, you probably don’t need the regulators to curtail your home loan options. But, if you don’t fit these criteria, you may need new rules to be put in place to save you from yourself. Florida home loans are expensive any way you look at it. Don’t make a disastrous mistake.