Mortgage Products Changing

November 23, 2005
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GRAND RAPIDS — The dollar volume of first-mortgage originations increased 10 percent from the second half of 2004 to the first half of 2005, and the popularity of nontraditional mortgage products rose, as well.

A recent Mortgage Bankers Association survey provides evidence of a shift in consumer demand from adjustable rate mortgages (ARMs) to interest-only (IO), alternative-A (Alt-A) and option ARM mortgage products.

Traditional adjustable rate mortgages (including interest) decreased from 46 percent of originations to 36 percent, while the share of interest-only loan originations increased from 17 percent to 23 percent. The share of Alt-A loan originations increased from 8 percent to 11 percent. Changes for option ARMs were not provided in the survey results.

The MBA survey polled more than 110 financial institutions, including the nation’s top 12 loan originators and 25 of the top 30 loan originators.

An adjustable rate mortgage usually has an initial interest rate of one year and after that has an adjustment interval of one year. The lender can adjust the interest rate during the life of the loan based on a comparison of interest caps and the indexed rate.

An option ARM allows the borrower to choose between payment options each month — either the minimum payment, an interest-only payment, or a 30- or a 15-year amortization payment.

With an interest-only mortgage, the scheduled monthly mortgage payment the borrower is required to make consists of interest only, so there is no repayment of principal — and the loan balance remains unchanged. The option to pay interest-only lasts for a specified period, typically five to 10 years.

The alternative-A, or Alt-A mortgage loan, is a 30-year fixed loan but is not a standard fixed-rate mortgage; it falls in a mortgage risk categorization just slightly behind prime. The Alt-A mortgage loan is just a little bit off an “A” mortgage loan, which has Fannie Mae- or Freddy Mac-conforming credit standards, explained John Burmeister, area manager of the mortgage group for Huntington Bank.

“The rate is a little bit higher, but it’s still a 30-year fixed loan that allows people to get into a home,” he added.

Alt-A mortgages are for people without traditional credit bureau information and for people with slightly damaged to severely damaged credit. The rate on an Alt-A mortgage is a little bit higher, either because of the customer’s debt load or credit score, according to Shirley Morford, vice president of National City Mortgage Co. in Kalamazoo. She said a customer’s income limitations and debt load might lead to an Alt-A mortgage as opposed to a more traditional mortgage loan. A foreigner moving to this country without any documented credit history could take advantage of this type of mortgage product, as well.

Doug Duncan, MBA’s chief economist and senior vice president, said consumers have shifted from traditional ARMs to nontraditional products because the difference between ARM rates and fixed rates is narrowing.

“While these new products provide consumers with a wide range of choices to meet their cash flow needs and risk tolerance, borrowers need to be vigilant to ensure that they prudently measure and manage the additional risk of these new products,” he warned.

Burmeister has seen the popularity of interest-only mortgages increase over the past two years. Huntington does a fair amount of interest-only mortgages but is not as aggressive about the program as some of the financial institutions in the West, Southwest and Florida, he said, basically because the Midwest — and particularly West Michigan — is a little more conservative.

“We do some interest-only mortgages with the idea that appreciation of the real estate is going to take care of equity build-up, and really all the customer needs to do is pay the interest on the mortgage loan,” he said.

Nontraditional mortgage products just weren’t that prevalent a few years ago; not many financial institutions offered them, he said.

“The robust nature of real estate in the last couple of years has made it apparent that at least for some people, it’s appropriate to do an interest-only rather than do a loan that includes amortization of principal, because the property is appreciating so quickly that they don’t need to be concerned about amortization of the debt.”

National City, too, is seeing an upswing in demand for nontraditional mortgage products in Kalamazoo, but not of the same magnitude that some cities are seeing, Morford said

“In our market, we are still very much a conventional lender. People still like that fixed rate stability,” Morford said. “But we have been getting more and more frequent calls, especially on interest-only mortgages. I think they are becoming a little more prominent because people can save on monthly cash flow, and I think in these economic times that’s why people are asking about those products.”

Michigan’s housing market is not appreciating as quickly as, say, the Florida, California and Arizona markets, she said. An interest-only loan program is more applicable in a market where home values are appreciating at a rapid pace. If not, an interest-only mortgage loan becomes more risky for the bank, she said.

For the mortgage customer, the interest-only mortgage is riskier in the sense that the buyer isn’t building any equity at all. The only potential equity increase is through appreciation of the property. On the other hand, a person relocating may be planning to stay just for two or three years and may not be that concerned about equity buildup.

“Mortgage providers and the mortgage industry have tried to be more creative with loan products to meet consumers’ needs, depending on how long they’re going to live on a property and what their financial planning is,” Burmeister said. “A 30-year fixed mortgage is still the No. 1 favorite, but it doesn’t work for everybody. It’s just a matter of us being more responsive to customer needs.”

The mortgage market has slowed recently in concert with the real estate market. But as Burmeister pointed out, that market always slows in Michigan in the months following the start of the deer-hunting season, the onslaught of winter weather, and the holiday season.    

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