The guvmint is concerned about the possible implosion of the housing industry due to so-called “exotic” mortgage financing, such as interest-only loans, pay option ARMs, and just plain old ARMs.
So, they’re gonna save us with (what else?) some new regulations!
The Comptroller of the Currency, with the concurrence of The Federal Reserve Board, held hearings in late September and quietly approved new regulations requiring lenders to underwrite such “exotic loans” under worst-case scenarios instead of the previously-used starter/teaser rates where anyone with a heartbeat could get a loan.
On the surface, this makes sense and had they acted sooner, they might have alleviated some of the impending trauma for borrowers with adjustable loans that are (gasp!) starting to, well, er . . . . adjust!
There is, however, more than a little absurdity involved in lumping all such financing tools in the category of “exotic”.
What about the homebuyer who gets transferred every 5 years? Is that homebuyer really going to benefit from getting a 30-year fixed loan that may cost more in both rate and fee? That buyer would probably be better off getting a 5/1 ARM because he will likely be down the road before the loan can adjust.
Then there’s the (Omigod!) dreaded, exotic, interest-only loan.
Let’s get a grip, guys ~ you aren’t paying much principle in the early years of a 30-year fixed-rate loan anyway!
Example: a $250,000 interest-only loan @ 6% interest works out to $1,250/month or $15,000 in payments in the first year.
If you amortize that same loan over 30 years, the monthly principle/interest payment is slightly less than $1,500/month, or $18,000 the first year.
Thus, the difference between interest-only and fully-amortized is only $3,000 ($250/month) in the first year of the loan.
If the buyers take the interest-only loan, they can simply add $250/month to their monthly interest payment to create their own amortization schedule and pay it off in 30 years, just as they would if they opted for the 30-year amortized loan.
And, if the borrowers encounter unforeseen financial challenges, they are only required to pay the $1,250 interest payment instead of the $1,500 principle/interest payment.
Pay option ARMs are an entirely different story. I would be the first to proclaim them as “exotic”; maybe even “stupid”.
I am proud to say that I have never allowed any of my clients to get one of them.
Call me conservative, but I can’t come up with any valid reasons for speculating on cyclical real estate values while concurrently skipping payments so you can end up buried even deeper when/if things go awry.
The unfortunate result of tightening these guidelines may be that some people will now be unable to refinance their way out of trouble as their ARMs reset from those tantalizing teaser rates that sounded so attractive when they got their loan.