Lenders roll out retooled wares
The mortgage industry has been busy reinventing itself.
Caught in a yearlong decline in business, lenders have taken a number of steps to shore up eroding loan activity. And there are some new -- and retooled -- mortgage products in the offing.
Not surprisingly, at-risk buyers are no longer the apple of their eye. Instead, lenders are courting the business of those with solid credit and steady jobs. For those borrowers, interest rates remain near historically low levels.
Even banks that were not stuck with bad loans have reassessed their product lines. Here is a sampling of what they are offering now:
Union Bank of California has come out with a 40-year loan in which the first 15 years have a fixed interest rate and borrowers can make interest-only payments if they wish to. At the end of 15 years, the loan makes a one-time adjustment to the market rate and is fixed for an additional 25 years.
“We call it a two-step mortgage,” said Craig Cole, the bank’s San Diego-based senior vice president and division manager for residential lending. The 40-year loan, offered to borrowers of jumbo (in excess of $417,000) mortgages, replaces one that carried a fixed interest rate for 15 years and then had a balloon, or lump sum, payment.
The loan, offered to borrowers of up to $2 million, most recently carried an initial interest rate of about 6.375% with no points and about 6% with 1 point down.
Although the market has traditionally been awash in five- and seven-year adjustable-rate loans and 30-year fixed-rate loans, the 40-year loan has been less common, though not unheard of.
Wells Fargo has a series of 40-year loan products in its portfolio, said Tom Swanson, the bank’s regional manager for mortgage lending in the Los Angeles metropolitan region, though they predate the current crisis.
“What’s old is new again,” said Bob Barron, a mortgage planner in the Solana Beach office of Mortgage Loan Specialists Inc. “My first home in 1987 had a 40-year loan from Glendale Federal. It comes in and out of favor.”
The difference, he said, is that two decades ago most mortgages were set as principal-and-interest loans; today, lenders have sought to create affordable options for borrowers by allowing them to pay only the interest for a period of years.
“They’ve come back a little more as interest-only loans, which I’m a big fan of,” he said, despite that “they get a lot of criticism in the media.”
The criticism stems from the fact that the switch from interest-only payments to principal and interest can result in a steep increase in monthly payments, often even higher because the interest rate has reset.
That just happened to a client of Barron’s.
The borrower, he said, took out a $430,000 loan three years ago at an interest rate of 4.1255%. Her monthly interest-only bill came to $1,478.13, until Nov. 1, when it converted to a principal-and-interest loan and the interest rate rose to 6.125%. That change caused her monthly mortgage payment to nearly double, to $2,716.82.
Despite the client’s sticker shock, Barron remains a fan of the interest-only formula banks are using to write loans, saying the problem isn’t with the loan. “Not having a credit-worthy borrower is the problem.”
Some lenders are still touting what are considered riskier, negative-amortization loans.
Steve Maizes, chief executive of the California office of Olympia West Mortgage, said some banks have compensated for the fall-off in business -- prompted, in part, by tighter lending guidelines -- by adopting loans with 1% “teaser rates.” With these loans, lenders allow borrowers to keep their payments low by paying a 1% rate for a period of time. The reality is that the loan still amortizes at, for instance, 7%, so the amount owed increases while the lower rate is paid.
“They say, ‘Hey, how would you like to pay 1% on a loan?’ ” he said. “The trick is that it’s 1% and the real payment is 7% and the borrower is incurring negative amortization -- the principal owed gets bigger and the interest rate [can] vary from month to month.”
Like the 40-year mortgage, teaser rate loans aren’t new to the market. What is new is that some banks that hadn’t offered them before now do, and some that did have tweaked their offerings, he said.
Robert Weiss, president of Rockland Financial, a mortgage brokerage in Simi Valley, called these products “bad loans for most [borrowers], but if they understand it and need it because they have feast or famine” income, they could work. Since much of Hollywood works on inconsistent income flow, these loans could prove popular.
To mitigate the potential for default that comes when 1% “teaser” loans are set to switch to their full payment schedule, some banks are converting those loans to five-year, interest-only adjustable-rate mortgages. The banks, he said, miss out on some of the money they would have been due under the old loan, but “would rather take a small loss now than a big loss in two years.”
The retooled offerings and tightened requirements coincide with a slight uptick in loan activity. The Mortgage Bankers Assn., a national trade group, reported on Nov. 14 that its Market Composite Index -- a measure of mortgage loan application volume -- had increased by nearly 2% over the previous four weeks, although it noted that the increase was heavily weighted toward refinance over purchase activity.
At the same time, according to DataQuick Information Systems, a La Jolla-based real estate information service, home sales in Southern California in October fell by more than 45% compared to the year earlier. Such slackened activity put added pressure on lenders to come up with ways to generate business.
The combination of low interest rates and flexible mortgage products that helped keep payments even lower fed the overheated sales market that led to the rapid run-up in prices, and the pullback in that market is seen as contributing to the slowdown in sales.
That’s why Jay Prag, a professor of finance at the Drucker School of Business at the Claremont Graduate University, is concerned about lenders and mortgage brokers using new products to generate more business.
Even with tighter lending standards and new, presumably safer, products on the market, he said a larger problem remains.
“I don’t think many people fully understand the ramifications of sophisticated mortgage products,” he said.
“Also, when rates are low, the idea of having a rate float isn’t scary,” he added. “The more they tweak the product, it really isn’t dealing with the problem: A lot of people believe they can own a house and handle the mortgage payments, and a lot just can’t do that.”
