NEWS: Bankers' Group Issues A Caution on Home Loans

By JAMES R. HAGERTY

Staff Reporter of THE WALL STREET JOURNAL

August 24, 2005; Page D3

The Mortgage Bankers Association, whose members have been promoting home loans with low initial repayments, urged consumers to choose such loans with care.

"Borrowers need to be vigilant to be sure that they are prudently measuring and managing" the added risks many accept by embracing loans that minimize monthly payments in the early years but can require much-higher payments later, the trade group said in a 30-page report released yesterday.

The report comes in the wake of recent warnings from Federal Reserve Chairman Alan Greenspan, bank regulators and the National Association of Realtors about the risks of such loans.

The mortgages in question include interest-only loans with rates that adjust periodically based on prevailing rates. With these loans, borrowers pay only the interest due during an initial period, often five years. Monthly payments then rise steeply as the borrower begins paying off the principal. Borrowers could face a double payment shock if the onset of principal payments coincides with a rise in interest rates.

Critics also have raised questions about the risks of "payment-option" loans. These loans give borrowers several payment options each month, including one that falls short of the interest due. When borrowers select that option, their loan balances increase -- something known among mortgage bankers as "negative amortization."

These loans are especially popular in California and other places where home prices are surging. The mortgage bankers' report said that these "innovative" mortgages help more people become homeowners. Still, the rising popularity of interest-only and payment-option loans exposes borrowers to "potentially substantial payment shocks," the report said.

Mitigating those risks, the report said, is an improving job market, which means more consumers will be able to afford higher loan payments. In addition, the report said, "there is only a small percentage of borrowers that are potentially vulnerable to an increase in [interest] rates or other economic shock." The report cited a Census Bureau survey showing that 35% of homeowners don't have any mortgage debt and an additional 50% have fixed-rate loans.

Competition among lenders, however, has spurred some of them to take more risks. Ameriquest Mortgage Co., Orange, Calif., one of the nation's largest home lenders, until last year avoided offering interest-only loans to subprime borrowers, those with blemished credit histories.

Spurred by rivals who were using interest-only loans to gain market share, however, Ameriquest began offering them to some subprime borrowers earlier this year. "We take what we consider a prudent approach to serve the interests of both our borrowers and our investors," an Ameriquest spokesman said. "We restrict interest-only loans to owner-occupied properties and require our interest-only borrowers to have higher credit scores."