Loans Just Aren’t What They Used To Be

There have been some recent changes regarding federal loan payment options. A “guidance” report was published on September 29, 2006 that spoke on the issue of mortgage payment options available to the public. The Federal Reserve, the Office of Comptroller of the Currency, the Federal Deposit Insurance Corp, the National Credit Union Administration, and the Office of Thrift Supervision all contributed to the the “guidance” report.

Each of the regulators mentioned above acknowledged that both, interest-only mortgages and the popular payment option (also called Pick and Pay) are legitimate forms of home financing. The popular payment option (Pick and Pay) allows the borrower to chose which level of monthly payments they wish to pay. This would normally give them the option to pay, Interest Only this option does not reduce the principal balance that is owed on the mortgage. This allows you to dodge the principal reduction by cutting the payments from the first three to ten years. At the end of that period the borrowers have the same balance they started with but then they have higher payments to reduce the debt over a shorter time frame. Then there is the fully-amortizing plan (P & I) that includes both the interest and the principal.

The regulators pointed out so long as the borrowers know what they are getting into, either of these loans are fine. However lenders tend to mass market the loans with a variety of add ons and it could be a bad combination. The government can foresee that there are problems lenders should try to avoid.

According to the report the biggest issue lenders should want to stay away from is lending to those who cannot support the full cost of the loan. When a mortgage is extended at a rate of 1% or 2% when we are in a market of 6.5% to 7%, that is acceptable the report said. However that only works if the borrower can afford the repayments at the higher level if and when they become due. If they can’t then extending the mortgage becomes a big problem. The report pointed out that just because the borrower can make the first few payments does not mean they can really afford the loan.

Lenders need to have documentation of the applicants’ income and assets. This is often difficult to do for those that are self employed. Stated income underwriting makes payment-options and interest-only loans a very risky venture. If the bank does not confirm information that the borrower is claiming to be true then the lenders should be weary of future problems with the loan.

Piggyback plans sound good but can and normally are very damaging to the borrower. For example a borrower can apply for a payment option first mortgage of 80% and then open a line of interest-only credit for the other 20% of the property value. They will pay nothing down and have no monthly payment. But when those payments do kick in, it can and will be a huge payment shock. Lenders should be conscious of whether the borrower will occupy the property or not. If the borrower did not plan on living at the property the chances are higher that it could go into foreclosure or default.

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