Interest Rate Roundup

Thursday, April 20, 2006

Another mortgage warning from the OCC

Check out this speech (given today in Los Angeles) if you have time:

It's yet another shot over the bow of high-risk mortgage lenders, this time from John Dugan, Comptroller of the Currency. The OCC (as his banking regulatory agency is known) is one of several that oversee operations at U.S. financial institutions. They've all been warning about the risk of today's super-high-risk loans.

What concerns them? Interest only financing and "option adjustable rate mortgages" allow you to get into a home with minimal payments up front. But those monthly payments are GUARANTEED to shoot up later on.

Why? You get to pay only the interest due for a few years (sometimes 3, sometimes 5 or more). But you have to eventually start paying principal. Since that principal is amortized (or divided) over a shorter period of time (say, 25 years vs. 30), your monthly costs jump EVEN IF RATES STAY FLAT. If they rise -- like they've been doing for almost two years now -- and you have an adjustable IO loan, your payment jumps even more.

As for option ARMs, they're even worse. You get to "choose" your payment: a normal 30-year-fixed-type payment, an interest only payment or a payment that doesn't even cover all the interest due each month. The problem is, WAY too many of today's overstretched borrowers are making just the minimum payment. When you do that, your unpaid interest gets tacked on to your loan principal. That means your balance goes UP over time, not down (a phenomenon called "negative amortization"). And guess what? You have to pay the INCREASED balance back ... over a shorter amortization period ... at a higher interest rate. Result: Your payments can as much as DOUBLE.

This kind of ridiculous financing is what helped inflate the housing bubble. Regulators were asleep at the switch for far too long, but they're finally doing something now. That will likely cause lending standards to tighten up, helping exacerbate the housing market slowdown. Soft landing? Not bloody likely!


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