Weighing the Risk
The days when consumers’ mortgage choices were limited to either a 15- or 30-year term, on either a fixed rate or adjustable rate plan, are long gone. With an eye on growing their loan portfolios while also putting homeownership within the grasp of more Americans, banks and mortgage lenders have over the last few years instituted a range of programs designed to do just that.
Among the most popular, and sometimes controversial, of these options is the interest-only loan, which was previously reserved for affluent homebuyers and/or investors looking to preserve their capital to use for other investments. Use of such mortgages has expanded over the last few years to include, for example, buyers with unpredictable incomes who can opt to pay only interest during the “lean” times, and interest-plus-principal, on their own accord.
Nontraditional Products Popular
Barbara Grunkemeyer, deputy comptroller for credit risk at the Office of the Comptroller of the Currency (OCC) in Washington, D.C., says such non-traditional mortgage products have been around for “at least 15 to 20 years,” and that demand for such products has picked up significantly in the last two to three years.
“Basically, when fixed rates started to go up,” says Grunkemeyer, “we saw some mortgage originators start to look creatively towards some of these non-traditional products that would qualify borrowers in an increasing rate scenario.”
These creative financing options have come under fire in recent years, due to the perception that programs like interest-only loans and adjustable rate mortgages (ARMs) can be risky in certain borrowing situations. First-time buyers with shaky credit history or a propensity to buy outside of their budgets, for example, can quickly find themselves in hot water when interest rates rise or balloon payments come due.
Sales associates should be aware of these risks when working with buyers, who may be so eager to get approved for a loan that they don’t factor in the implications of a non-traditional mortgage lending product. “Like shoes, one size does not fit all,” says John O’Connor, sales manager at Wells Fargo Home Mortgage in Jacksonville.
Finding the Best Fit
O’Connor points out that just because a loan officer recommends an interest-only or ARM option—or, a combination of the two—that doesn’t necessarily make it a risky venture. “It may simply be the best fit for the customer,” says O’Connor.
Because first-time buyers can be particularly vulnerable to risky lending opportunities, O’Connor urges sales associates to err on the side of caution when working with them. “Conservatism should be kept in mind at all times,” he says. “A lender may be more than willing to lend more than can be easily managed by a first-time buyer, so focus on the overall monthly payment and whether it will be easily managed by the buyer. If not, then either wait, or lower their purchase price range.”
O’Connor says first-time buyers should avoid interest-only loans, namely because those purchasers usually need higher loan-to-value loans. “It’s important to build equity into a payment for a first-time buyer, in order to put some ‘cushion’ between what is owed, and the value of the home,” says O’Connor, who sees that strategy becoming more important than ever in today’s changing real estate market. “Now more so than in recent years, this is quite important as appreciation rates have slowed in most markets across Florida.”