The high cost of interest-only initial payment loans

Mortgage giant Fannie Mae plans to raise a previous 1.25% fee charged to lenders to 3.25% -- and yes, that is passed on to the consumer -- on some types of mortgages it purchases. Saturday's Wall Street Journal had a short write-up on it.

For instance, for a 30-year fixed-rate mortgage to buy a condominium, allowing for initial payments of interest only and with a 20% down payment, a borrower with a credit score of 690 will pay fees totaling 3.25% of the loan amount for mortgages Fannie purchases after April 1. ...

A Fannie spokesman said the higher fees are targeted at some of the highest-risk loans, such as those allowing deferment of principal payments and those allowing borrowers to draw cash when they refinance.

The National Assn. of Realtors registered its displeasure in a letter to Fannie protesting the "major new costs" on buyers and people seeking to make their loans more affordable through refinancing.

Let's back up the truck here. The 20% down seems very respectable, but why, oh why, are they still offering interest-only "teasers"? What happens when the entire payment kicks in -- particularly if the property has dropped in value since the purchase? I'm not following the logic.

--Lauren Beale

Thoughts? Comments?

Comments

[ah]

Hi Lauren,

What you're saying is that in your world there is no place for adjustable rate mortgages, and I think that is complete bunk. If you'd have complained about products that don't pay down principal -- which is what the GSEs are taking issue with -- that's a fine argument.

Basically, these aren't teaser rate products. They're normal adjustable rate mortgages, which people often choose. I don't know what the shortest duration is, but it's certainly at least 3 years, and I suspect 5 is more common. Properly underwritten, even the IO versions make sense for many borrowers, like those who don't intend to stick around for the long-term or with inconsistent incomes. By appropriately underwritten, I mean the borrower must have the capacity to repay the amortized payment schedule.

I mean, I know Tribune doesn't offer bonuses, but many jobs so. If you have inconsistent but high income with the discipline to pay down the mortgage instead of blowing it on coke and whores, then an IO product might make sense. I guess you could argue that person doesn't exist, but I know they do.

So, I'm just confused by the outrage -- to get this loan you have to qualify to pay off the amortizing portion of it, pay a huge fee, and your "teaser rate" is going to be 5% or more, based on what I see at Bankrate. You can do 3, 5, 7 and 10 years IO, which doesn't seem to me to be "teaser" in any sense of the word "teaser." An MTA option arm that changes every month -- that's a teaser. This product, not so much.

[Cal]

Outside the fees the rates on IO's lately have made payments relative to amortizing loans about the same, this should kill any of the remainder off.

IO were "affordability" products offered because the borrower couldn't qualify for amortizing loans. Well, the lenders didn't care that much during the boom it is more accurate to say that IO's provided the borrower with a payment they found acceptable. It was more about finding a sucker than getting paid back since the lenders were lending OPM. They were more profitable for the lenders to originate as well.

There are a LOT of IO loans in California. I also dont know of any loan mod program that doesn't require principal repayment. So someone can get their interest rate reduced but their payments stay the same or go up because they have to start paying off their loan. Some lenders are re-amortizing the loan over a 40yr period so that the people getting the mod will stick with the payment (even though it is a horrible "deal" for the borrower).

[Lauren Beale]

Hi Ah,
I've had adjustable rate mortgages before -- worked just fine for me. But they were not interest-only. I was paying down the nut. In a particular in a market where prices are going down, I don't see how interest-only is a good idea.
We've just come off a bad year of people defaulting on mortgages and losing their homes. I guess Fannie thinks the 3.25% fee is enough to cover its risk but my concern is this scenario just helps set people up to fail.
Lauren Beale

[LA-renter]

Lauren, please back off.

The temporarily wealthy are feeling mighty sore right now. Out of work high-incomers have extra time to surf the internet, looking to find their next big kill... then they find a party-pooper like you.

ah: For the masses affected by the heavy hand of government, those not intending to stick around... inconsistent income... why not just rent? Is it because of the tax benefits of homeownership?... One more reason to get rid of this government interference.

[Lou]

There are times for loans like these just like their original intended purpose. Option-ARMs should be for investors who put 30% down and have reserves who just need it for cashflow issues. That's it. The loan in any other circumstance is a foreclosure waiting to happen.

[Mari]

I am currently refinancing to reduce my monthly payment. I have 50% equity counting a 60K line of credit -second. US bank, who holds the line of credit has notified me that they will NOT subordinate my line of credit unless I refinance the first mortgage through them. Can they hold my house hostage -- my refi was to be for 30 years at 4.8%. Seems like they should have disclosed this when I signed for the line of credit. I don't want to roll the second into the first because I wanted to pay the second off over the next five years and have smaller payment for the first. Can they do this?

[Cal]

Mari,

Yes they can do that. They can choose to subordinate or not and they choose not.

You might ask why they wouldn't subordinate. They will either make money on your refi (and thoroughly vet you so they know absolutely that the HELOC is safe) or by freeing up money from the HELOC being paid off (which are riskier in downturns) . Either way they are safer for it, i'd counter with an offer to refi through them if they match the fees and rates of the refi you were going to do with someone else.

[tonylogan]

When will people figure out that it is no business of the government to decide if an ARM or IO loan is appropriate?

If the government would stop backing the loans altogether, then the banks would just make loans that are profitable, or go out of business.

The bottom line is that if the government is going to be in the business of backing home loans, at least they should avoid backing the incredibly stupid ones. (IO and all ARMS)

[coakl]

Underwriting is the key here. And for the past five years, there were precious little underwriting done on these loans. To increase loan approvals, lenders conveniently ignored whether borrowers could afford a fully amortizing payment. Everything was predicated on whether the borrower could afford the smallest payment option. If so, the loan sailed through.

Just ask the shareholders and laid-off employees of Washington Mutual what they think about interest-only loans.

And don't forget to chat with J.P. Morgan Chase shareholders....many of those toxic loans from WaMu are now in Chase's portfolio and are due for resets in 2010-2012.