News
12-11-2006, 10:00 PM
Know Your Risk Tolerance To Choose the Right Loan
By Kirstin Downey
Washington Post Staff Writer
Sunday, October 1, 2006
The real estate lending market has changed dramatically in the past five years, and while borrowers have more opportunities than ever before, they also have more opportunities to make mistakes.
Homeownership nationally stands at a near-record 68.7 percent. Lending standards are looser than they have been in more than 50 years, and interest rates remain low.
That's good news for many prospective homeowners, because owning a home has usually been the first step up the ladder of prosperity.
Now buyers with good credit can almost dictate the terms of the loans they will receive, and even people with bad credit can get loans that once would have been unattainable. No down payment? No problem. Can't afford the payment on the house you really want? That's okay. Bankrupt? Oh, bad luck, you'll have to pay a bit more.
But the loosening of credit also means that borrowers have to be more vigilant than ever before. On Friday, federal regulators told lenders they must provide more information to borrowers and make sure consumers have money to repay the loans.
Once mortgages came in basically two varieties: fixed-rate, usually for terms of 15, 20 or 30 years, and adjustable rate, also for those same lengths of time, but where the mortgage amount could fluctuate depending on whether interest rates rose or fell. People usually get a slightly lower interest rate on a loan where the rate can float up and down, because the lender is giving the borrower a cut in the price in exchange for assuming some of the risk as rates fluctuate. In 2000, about 85 percent of all mortgages outstanding were fixed-rate. People usually could get home loans only if they had good credit, steady work and a substantial down payment so they would have some of their own cash at risk.
But starting about five years ago, variants that had been developed for the wealthy were introduced to the broader market. They are unusual enough that Alan Greenspan, former chairman of the Federal Reserve, dubbed them "exotic" loans.
Interest-only loans, for example, require people to pay only the interest on the loan each month, adding the principal payment to the check only if they wish to do so. That can save people hundreds of dollars each month and make even high-priced housing affordable.
"Option" loans give borrowers a choice of payments each month, either the full principal and interest, an interest-only payment or some lower payment. They allow people to buy homes for which they would otherwise never be able to qualify based on the old income and debt ratios. Most of these new variants are adjustable-rate loans, but some offer fixed-rate features for some period, three years or five years, or even up to 10 years.
This means borrowers today can choose among hundreds of permutations. If you are a traditionalist, you may want to follow the time-tested borrowing options that have worked for generations. If you are an adventurer, a person willing to take a risk to live in a nicer home than you could otherwise afford, with money to spare to invest elsewhere, then the potential threat of higher payments in the future -- and even foreclosure if home values plunge -- could seem only a distant danger.
These nontraditional loans are sold to investors on the secondary market in packages of securities. These investors -- including hedge funds and institutions -- have allowed the standards to loosen to include making loans to people with very poor credit, to those who have no down payments, to those who decline to reveal their income or its source and even to those who have recently gone bankrupt.
Lenders will seldom give loans to people who have all of those problems, but are often willing to work with borrowers who have one or two. That's because investors have found that most people will work hard to save their homes from foreclosure and that few people walk away from home loans, especially when, as happened in much of the last five years, real estate values rise.
But when borrowers take out "option" ARMs, for example, and make the minimum payment on the loan, they will end up seeing their mortgage balance, or what they owe on the house, increase with time, not fall. People who have a mortgage that is higher than the price they can get if they sell the house have to pay money to the lender at the closing table to get out from under the loan. If they can't find a buyer or don't have the extra cash on hand, they can lose the home to foreclosure. These loans have only emerged on the market in a big way in the past five years, and nobody really knows what could happen to them in a prolonged down cycle in real estate.
By Kirstin Downey
Washington Post Staff Writer
Sunday, October 1, 2006
The real estate lending market has changed dramatically in the past five years, and while borrowers have more opportunities than ever before, they also have more opportunities to make mistakes.
Homeownership nationally stands at a near-record 68.7 percent. Lending standards are looser than they have been in more than 50 years, and interest rates remain low.
That's good news for many prospective homeowners, because owning a home has usually been the first step up the ladder of prosperity.
Now buyers with good credit can almost dictate the terms of the loans they will receive, and even people with bad credit can get loans that once would have been unattainable. No down payment? No problem. Can't afford the payment on the house you really want? That's okay. Bankrupt? Oh, bad luck, you'll have to pay a bit more.
But the loosening of credit also means that borrowers have to be more vigilant than ever before. On Friday, federal regulators told lenders they must provide more information to borrowers and make sure consumers have money to repay the loans.
Once mortgages came in basically two varieties: fixed-rate, usually for terms of 15, 20 or 30 years, and adjustable rate, also for those same lengths of time, but where the mortgage amount could fluctuate depending on whether interest rates rose or fell. People usually get a slightly lower interest rate on a loan where the rate can float up and down, because the lender is giving the borrower a cut in the price in exchange for assuming some of the risk as rates fluctuate. In 2000, about 85 percent of all mortgages outstanding were fixed-rate. People usually could get home loans only if they had good credit, steady work and a substantial down payment so they would have some of their own cash at risk.
But starting about five years ago, variants that had been developed for the wealthy were introduced to the broader market. They are unusual enough that Alan Greenspan, former chairman of the Federal Reserve, dubbed them "exotic" loans.
Interest-only loans, for example, require people to pay only the interest on the loan each month, adding the principal payment to the check only if they wish to do so. That can save people hundreds of dollars each month and make even high-priced housing affordable.
"Option" loans give borrowers a choice of payments each month, either the full principal and interest, an interest-only payment or some lower payment. They allow people to buy homes for which they would otherwise never be able to qualify based on the old income and debt ratios. Most of these new variants are adjustable-rate loans, but some offer fixed-rate features for some period, three years or five years, or even up to 10 years.
This means borrowers today can choose among hundreds of permutations. If you are a traditionalist, you may want to follow the time-tested borrowing options that have worked for generations. If you are an adventurer, a person willing to take a risk to live in a nicer home than you could otherwise afford, with money to spare to invest elsewhere, then the potential threat of higher payments in the future -- and even foreclosure if home values plunge -- could seem only a distant danger.
These nontraditional loans are sold to investors on the secondary market in packages of securities. These investors -- including hedge funds and institutions -- have allowed the standards to loosen to include making loans to people with very poor credit, to those who have no down payments, to those who decline to reveal their income or its source and even to those who have recently gone bankrupt.
Lenders will seldom give loans to people who have all of those problems, but are often willing to work with borrowers who have one or two. That's because investors have found that most people will work hard to save their homes from foreclosure and that few people walk away from home loans, especially when, as happened in much of the last five years, real estate values rise.
But when borrowers take out "option" ARMs, for example, and make the minimum payment on the loan, they will end up seeing their mortgage balance, or what they owe on the house, increase with time, not fall. People who have a mortgage that is higher than the price they can get if they sell the house have to pay money to the lender at the closing table to get out from under the loan. If they can't find a buyer or don't have the extra cash on hand, they can lose the home to foreclosure. These loans have only emerged on the market in a big way in the past five years, and nobody really knows what could happen to them in a prolonged down cycle in real estate.