Risky mortgages could be harder to get
By Kathy Chu, USA TODAY
Posted 12/14/2005 12:13 AM

Qualifying for a low-payment, high-risk mortgage is getting harder.

Federal regulators plan to issue a notice this month that could make lenders more hesitant to offer "non-traditional" mortgages — such as interest-only loans and option adjustable-rate mortgages — to people with weak credit or finances. In the third quarter, 33% of first mortgages approved by lenders were non-traditional loans, compared with 1% five years ago, according to LoanPerformance, a research firm.

Interest-only and option ARMs are fairly complex mortgages. Typically, borrowers make artificially low payments for a period, such as five years. Afterward, payments shoot up to reflect current interest rates and the principal owed. Regulators worry that some borrowers lured by these mortgages' initial low payments won't be able to handle higher payments later. Lenders would then be at risk for loan defaults.

Interest-only loans and option ARMs have likely contributed to the surging housing market, because they let borrowers buy more expensive homes than they normally could afford. Non-traditional mortgages have become more widely available as companies have rushed to meet demand. Quicken Loans, for example, began offering option ARMs this year and interest-only loans two years ago.

If non-traditional mortgages become scarcer or if borrowers turn away, "That could have a cooling effect" on the housing market, says Glenn Costello, a managing director of Fitch Ratings.

Borrowers who use such loans would see their mortgage balances rise over time if their monthly payments don't cover the loan's interest, Federal Reserve Governor Susan Bies has warned. And lenders risk higher defaults if they ease up on safeguards, such as verifying borrowers' income, Bies says. Regulators plan to formally weigh in on the risks of these mortgages by year's end. The notice will address how banks qualify borrowers for loans, the lenders' portfolio risk and the "payment shock" borrowers could face as their payments rise, says Barbara Grunkemeyer of the Office of the Comptroller of the Currency.

The likely result? This will "pressure lenders to tighten standards," says Keith Gumbinger of HSH Associates, a publisher of loan information. "That may mean that somewhat fewer borrowers qualify."

Some mortgage lenders aren't waiting to take action. New Century Financial says it's cutting back on interest-only loans because they were "highly concentrated in the (company's)portfolio" during some quarters. Washington Mutual and Golden West Financial have raised the introductory interest rates on option ARMs in recent months.