Homeowners Pile On the Risk With Adjustable Loans
By DANNY KING
Could all that floating in local mortgages lead to a bubble?
That's what real estate industry watchers are pondering as more homeowners forsake standard 30-year fixed mortgages for the floating rate variety.
For November 2003, the most recent figure available, 52.9 percent of Los Angeles County homebuyers purchased their homes with adjustable rate mortgages, according to DataQuick Information Systems. That's up from 29.5 percent for the year-earlier period and represented the highest figure in nearly nine years.
Much of the increase is the result of a widening gap between long-term fixed rate and shorter-term adjustable rate mortgages, according to both John Karevoll, an analyst at DataQuick, and Robert Kleinhenz, deputy chief economist at the California Association of Realtors.
With 30-year rates hovering around 6 percent and adjustable-rate mortgages available at less than 4 percent, the spread between the two mortgage types is about 2.2 percent, versus 1.9 percent a year ago.
Adding to the trend is that many mortgage products keep a fixed rate for five to seven years before becoming adjustable. "People were being overly risk averse (a year ago) by choosing fixed-rate mortgages," said Karevoll. "People are doing the math now to a greater degree than a year ago."
By choosing a floating rate mortgage, new homeowner Ted Hong estimated he is saving about $200 a month in mortgage payments for a West Los Angeles townhouse.
"It's definitely a starter home, so we figured there'd only be a 15 to 20 percent chance we would actually still be there in five years," said Hong, married with a one-year-old son. "It's a bit of a crapshoot, but if I'm coming up on five years, I'll address it (by refinancing)."
Southern California's steadily higher housing prices help explain why some homebuyers are turning to cheaper adjustable-rate mortgages as a last resort. In November, the L.A. County median home price was $339,000, up 21 percent from $281,000 a year earlier, according to DataQuick.
Meanwhile, just 24 percent of L.A. County households could afford a median-priced home in October 2003, down from 31 percent for a year earlier, according to the California Association of Realtors.
But the move to adjustable rates could be risky if mortgage rates rise, as expected. That would increase monthly payments for adjustable mortgage holders and may level off home values, said Edward Leamer, director of the UCLA Anderson Forecast.
"There are people who are in trouble and are moving into short-term maturities because they can't do it any other way," said Leamer. "That's very troubling if in a year from now interest rates are higher."
While the jump in adjustable mortgages is a reflection of entry-level homebuyers stretching to get into the market, the increase is across the board as more high-end buyers opt for floating rate loans, according to Mark Cohen, chief executive of Beverly Hills-based mortgage broker Cohen Financial Group.
"People are trying to figure out ways to afford homes," said Cohen, whose average mortgage is in the $500,000 to $600,000 range. "(Adjustable rate mortgage origination) is definitely the bulk of the business."
A big question is whether the adjustable rate preference foreshadows foreclosures and a falling market.
In September 1988, 67 percent of new homebuyers in L.A. County used adjustable rate mortgages, the highest monthly figure DataQuick has ever recorded on mortgage preference in the county. That figure remained above the 60 percent range through mid-1989, about two years before the real estate bubble burst. Between 1991 and 1995, median home values in L.A. County fell 13 percent while notices of default, a precursor to foreclosures, doubled between 1990 and 1996.
For November, the state's highest percentage of homebuyers using adjustable rate mortgages, at more than 68 percent, was in Santa Clara County, where the tech bust has had its most severe effect. With that in mind, said Leamer, "there is no question we will have elevated foreclosures."
Still, history is not likely to repeat itself. The current spate of adjustable mortgage usage is different than that of the late '80s, said Karevoll. Because the interest rates on fixed and adjustable mortgages were nearly identical back then, "adjustable rate mortgages were a clear indication that people were being pushed onto thin ice," he said.
Additionally, more than 10 percent of adjustable rate mortgages in the late '80s were either interest-only loans or negative amortization mortgages (where monthly payments are less than the interest charges and home equity is gradually decreased). Today, that figure is less than 2 percent, said Karevoll.
Finally, the Southern California economy is unlikely to undergo the same contraction as it did in the early 1990s, when the loss of defense jobs sent the region into a steep economic downturn. Kleinhenz expects L.A. County's median home value appreciation to be higher than the 13 percent statewide forecast, although he does see some erosion from the recent boom.
"We're talking about an economy that will expand in 2004 and 2005," he said. "(A household's) ability to service that loan should improve as the economy improves."
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