More Americans are Losing Their Homes due to Risky Loans

Every time I write a piece about interest-only mortgages or no-money-down loans, I always get a comment that goes something like this one left recently:

Interest-only and 100% mortgages can be used for evil, but they can also be used for good, IF you are financially savvy AND disciplined. Leverage can be a beautiful thing. I have an 80/20 interest-only loan. Before I bought the house, I calculated the max I wanted to spend on housing (25% of gross), figured out what regular mortgage I could comfortably afford below this figure, then took out the IO version of the loan. The 80/20 option allowed me to avoid $100+ in PMI every month. It also freed up cash for other investments. With rebates, seller incentives, and carefully vetted closing costs, I bought my house with a total investment of $335.00. I always pay what the full P+I payment should be plus an extra 10%. In 9-months, my house's value has increased $40,000. Even if I had to pay a realtor to sell tomorrow, my gain would be close to 90%. Leverage is a great tool. You just have to make sure you don't get too greedy. Banks approved me for 100K more than I was willing to spend. The problem is not will IO loans, but what people do with them.

I've said before that it's POSSIBLE for these loans to be used properly, but most people do not use them that way and no one can count on a $40,000 home value increase in nine months. As such, I'm not a big fan of these sorts of loans. The way the vast majority of people are using them (to buy a house they can't afford), these loans are financially dangerous.

So I just had to share this piece from MSN that talks about U.S. home foreclosures rising 45% in January. The reason? Aggressive borrowing with these sorts of loans. Here are the details:

The number of foreclosures is still low on a historical basis, but it has been rising steadily over the past year, RealtyTrac reported. Job losses in some regions were to blame, but so, too, were risky borrowing practices that left homeowners little wiggle room on their mortgage payments. And with the pace of appreciation stalling and interest rates rising, many economists and industry observers expect the pace of foreclosures to accelerate this year.

Typically, analysts say, it’s a job loss or loss of income from a household breadwinner that drives defaults. But rising interest rates are also beginning to play a role. “You have a lot of people who stretched to get into a house,” said John Tuccillo of Arlington, Va.-based real estate consulting firm JTA Inc.

In the last few years, many buyers took out interest-only, variable-rate loans, and in some cases put no money down to afford a house, said Frank Nothaft, chief economist with government-chartered mortgage giant Freddie Mac. He estimates one out of every three loans issued in 2005 was an adjustable rate mortgage. Now that we’ve seen 14 consecutive interest-rate increases since June 30, 2004, many of these loan rates are bumping up, increasing the size of mortgage payments.

Nothaft estimates that $500 billion in variable rate mortgages will reset, or rise, sometime this year, leaving many with a payment they can no longer afford. “Those would be the candidates for … delinquent status,” he said.

What happens in most cases with interest-only/no-money-down loans is that people stretch almost to the breaking point to afford the biggest house they can get. Then, when something happens that causes a financial hiccup (like loss of a job, unexpected major expense, etc.), the whole house of cards comes down. I think we'll be seeing more and more of this in the coming years.

One of my friends uses a financial planner for money guidance and he told me that his planner says it's commonplace to meet with potential clients at their homes. He says that in almost every case where he drives up to a huge house, he goes inside to see it sparsely furnished or the people using furniture they've had for years and years. Then he looks at their finances and sees that they've spent every last dime and mortgaged themselves to the hilt to get the biggest house possible.

So you may argue with me that these are really good loans as long as they're used in the right ways, by the right people, at the right time, etc., but the fact is that the vast majority of people aren't using them in any way other than to buy a house they can't afford.

To end, I thought you all would enjoy this cartoon I found the other day. :-)

Comments

[Ryan]

Great post, I am a new reader who lives in Las Vegas. I work in the lending industry and see people in these loans everyday. It is so funny to me to hear people my age (29) talk about the stability of the housing market and so on, when they were not old enough to remember the last time the bottom fell out. Anyway thanks for the great site.

Ryan Tomaino

[Julie]

Take a look at the article below: "Interest-only mortgage deja vu" it talks about the problems of interest only mortgages in the 1920s and how new adjustable interest only mortgages are only making matters worse for uninformed homeowners.

http://www.bankrate.com/brm/news/mortgages/20050512a1.asp

[mapgirl]

Great article! I'll be linking to it tomorrow. If could figure out exactly how trackbacks work, I'll make it appear here.

[FMF]

mapgirl -- Put this trackback code (above):

http://www.typepad.com/t/trackback/4425724

in the spot where it says "sites to ping" (or some similar wording) in your blogging software. Then, when you publish the post, it will leave a link here.

[Demitrius]

Timely article. I always caution my clients from over extending themselves. Pity some of them don't listen. Sometimes doing what is best for the client causes the client to go with another company. And that's fine with me.

[Shelly & Daniel Hicks]

Over two years ago we refinance our house amd the apprl. came in at 165000 and now they are telling us the our house is only worth maybe 110-120 if were to try to sell... We aren't even able to refinance to get our monthly payments lower. We are currently paying 1400.00 each month and this does not include taxes and insurance. Any help they you may be able to give us would be so greatly appriciated..

Thanks for your time..

Shelly Hicks

[FMF]

Shelly --

Do you have a specific question?