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The mortgage party of 2003-06 is so, so over.
Darci Rickson now wishes that she'd looked closer at the fine print. So do Norman and Margaret Paige. And doubtless thousands of others -- soon to be millions -- whose cheap, fixed-rate introductory periods are about to expire.
The owners of about 7.7 million adjustable-rate loans taken out in 2004 and 2005 -- about $1.89 trillion worth -- face higher house payments in the next two to three years, says Christopher Cagan, the research director for First American Real Estate Solutions of Santa Ana, Calif. That's about a fifth of all mortgages outstanding in the U.S. right now.
These are not traditional mortgages. Rather, they are complicated, sometimes bafflingly intricate contracts loaded with changing rates and back-end details that trip up unsophisticated borrowers. One category, subprime loans, is aimed at the poor, minorities and people with bad credit -- in other words, those who can't, or think they can't, get a loan by other means.
Jordan Ash, the director of community activist group ACORN's Financial Justice Center in Minneapolis, blames the mortgage industry for aggressively marketing expensive loans that only the savviest consumers can understand to people with little money and flawed credit. "In the mortgage world, it's not a competition of who can give you the best rate -- they're all offering basically the same loans," Ash says. "It's who gets to you first and reels you in first. It's who has the best sales pitch."
The plain old adjustable-rate mortgage spells trouble enough. But three high-risk loans are causing most of the trouble:
- Teaser ARM. This loan features an alluring initial period of very low interest, around 1% to 2%, which later resets to market rates. About 1.4 million borrowers will be jolted back to reality in the next two to three years as their introductory periods expire. Payments on a $200,000 loan at 2% are about $725 a month; at 7%, they're $1,340.
- Subprime ARM. Nearly half of loans due to reset are aimed at low-income people, minorities and people with bad credit -- folks who can't or just assume they can't get a bank loan at a reasonable rate. Many are in a shaky financial position to begin with and so are in greater danger of defaulting. Subprime (also called nonprime) ARMs start high -- 7% or more -- and go higher. And higher. They often feature a fixed, lower-rate introductory period. But when that ends, it's "just the old-fashioned squeezarooni," Cagan says.
- Option ARM. This is the real killer. It gives homeowners the choice each month of paying the principal and interest, just the interest or an even-smaller minimum amount. Every month you pay the minimum, you're deeper and deeper in the red. And up to 80% of option-ARM buyers pay only the minimum, according to Fitch Ratings. Because the minimum payment doesn't cover the monthly interest, the deferred interest is added to the loan balance. After the loan balance grows to a certain point, the lender will demand that you start paying the full principal and interest -- on your now-bigger loan.
There are 400-odd varieties of mortgages, and some combine several nasty features in a single loan. One example: On a five-year teaser loan for $200,000 -- one with a 1.25% introductory rate, 7.414% fully indexed rate with a 2.75% margin and a 7.5% payment cap, if you're keeping score -- a homeowner could make minimum payments that rose from about $670 to $770 over the fixed term. At the end of five years, deferred interest would have inflated the balance on the loan to nearly $220,000. The new monthly payment, one that paid back all the interest plus the principal? About $1,600. Is there any wonder why buyers are confused?
"The products are getting more and more complicated, and it's harder and harder to understand them and make an informed choice," Ash says. "Lots of people did not know what they were buying. I had one person who came and said, 'I make my payment I every month, and every month my loan goes up. How can that be possible?'"
How could things be worse? Easy: Many of these loans also have prepayment penalties, so you're nailed with fat fees if you try to refinance or pay off the balance early.
Cagan, who conducted a February 2006 study, "Mortgage Payment Reset: The Rumor and the Reality," predicts that the U.S. will weather this mortgage problem, but he's not saying it'll be easy. It's a bump, not a catastrophe, for the economy, he says.
The story of a homeSo far, just the homeowners who bought these cheap loans early, or whose introductory periods were short, have been hit. "We haven't had a lot of people lose their houses to reset yet. That's proof it hasn't really bit yet," Cagan says.
But Norman Paige knows better: He and his wife, Margaret, have seen their mortgage payment go from $729 a month -- at a fixed rate of 7% in 2003 -- to $956 a month today, after their fixed-rate period ended in 2005.
The Paiges bought their home in 1974 with a government-assisted loan for veterans. They reared three children there and over the years refinanced it three times to pay for repairs and upgrades. Paige has lost track of how much equity they have in the house.
The Cleveland-area residents recently filed for bankruptcy and relinquished a rental house to foreclosure, so Paige doubts he could refinance again. "There's nothing I can do now," he says, but devote more of their $4,200 monthly fixed income to housing and be grateful that his pension is a good one. He is kicking himself: "I just got messed up. You want to get mad, but you can't get mad at nobody but yourself."
Foreclosures in the U.S. jumped 24% from July to August. The 115,000 foreclosure filings in August were "the biggest spike we've had all year" -- a 53% increase in foreclosures from August 2005, says Rick Sharga of RealtyTrac, an online foreclosure marketplace. "The fact is, we've never had this many of this type of loan mature all at the same time, so there really is not a precedent for this."