| Adjustable rate mortgages will be time bomb for low income { July 25 2004 } Original Source Link: (May no longer be active) http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=1087373959624http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=1087373959624
US homebuyers risk rates 'time bomb' By Jenny Wiggins in New York Published: July 25 2004 17:04 | Last Updated: July 25 2004 17:04 A red hot housing market and higher interest rates are pushing increasing numbers of US homebuyers into the most risky kinds of mortgages, spelling trouble for financially stretched consumers in years to come.
The Consumer Federation of America will on Monday release a report warning of a potential financial "time-bomb" due to an increasing interest among low-income consumers in adjustable-rate mortgages at a time of rising interest rates.
US homebuyers have traditionally favoured fixed-rate mortgages, which allow them to pay the same rate of interest on their home loans for up to 30 years.
But as homes become increasingly difficult to afford and higher interest rates make fixed mortgages more expensive, more homebuyers are taking out more risky adjustable mortgages, for which the rate varies.
"People are saying: 'The only way I can afford to get a house is to get an adjustable-rate mortgage,'" said Joseph McKenzie, deputy chief economist at the Federal Housing Finance Board, adding that there are no signs yet of significant price declines in the booming US housing market. Adjustable mortgages are initially cheaper than fixed mortgages, making it easier for consumers to buy homes. The percentage of adjustable mortgages taken out has more than doubled over the past year, rising to 36 per cent of all loans closed at the end of May, according to the housing finance board.
Economists say consumers typically favour adjustable mortgages in periods of rising interest rates because fixed mortgages become more expensive. "The same thing happened in 1994 and 1999," said Doug Duncan, chief economist at the Mortgage Bankers Association. "The pattern is repeating itself." However, mortgage analysts are worried by the increasing numbers of low income borrowers with poor credit quality that are taking out adjustable loans. The payments on these loans will increase as interest rates rise, possibly creating financial stress.
"There are some borrowers who are selecting these products not out of desire but out of necessity and it may come back to haunt them," said Keith Gumbinger, vice-president at HSH Associates, an independent mortgage research firm. "Some of the products that are being originated today will turn into the foreclosures of tomorrow."
Around two-thirds of all mortgage debt held by "sub-prime" borrowers - borrowers with poor credit histories - is in some kind of variable-rate product, up from around one-third in the mid-1990s, according to Fitch Ratings.
To be sure, many adjustable mortgage allow consumers to "fix" rates for a certain period of time - up to 10 years - making them useful options for short-term homeowners.
But the mortgages taken out by sub-prime borrowers typically adjust after just two or three years, making them particularly vulnerable to higher interest rates, according to Sarbashis Ghosh, a senior director at Fitch.
The increasing number of adjustable mortgages owned by sub-prime borrowers is potentially dangerous for investors. Homeowners with adjustable mortgages are more likely to default than homeowners with fixed mortgages and more than half of all mortgage loans issued in the US are packaged into securities and sold to institutional investors.
"Less-than-prime mortgage borrowers are thus effectively borrowing from investors willing to shoulder the higher risks involved," said Mark Zandi, chief economist at Economy.com.
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