Increasing numbers of L.A. homeowners are taking out mortgage loans with low initial payments and high back-end payments, making a huge bet that housing prices will keep rising sharply.
If they are wrong and the housing market slows, not only could they be wiped out financially, but they could take a major chunk of the local economy with them.
Forty-two percent of home purchases in L.A. County so far this year have used interest-only loans an all-time high since such mortgages were introduced about three years ago and more than 50 percent above the national average, according to data compiled by Loan Performance, a unit of Anaheim-based First American Real Estate Solutions L.P. More than one-fourth of all home loans, including refinancings, are being issued with interest-only payments.
"There's a big risk here, especially for people who bought recently at what may be the top of the market," said Celia Chen, director of housing economics for Economy.com, a West Chester, Pa.-based economic consulting firm.
Interest-only loans offer enticing low monthly payments for the first three to seven years, often allowing people to buy homes they might not otherwise be able to afford. During that time, homeowners do not have to pay down the loan balance making payments easier at a time when average home prices have topped half a million dollars in many parts of L.A. County.
But once the borrower begins paying down principal, the payments rise substantially. If home prices stagnate or decline, borrowers could find themselves in an "upside-down" position, increasing the risk of a default.
The spillover effects could result in lower consumer spending and a general tightening of credit as lenders face higher bad loan ratios.
There is anecdotal evidence that interest only-loans are beginning to drop in popularity now that long-term interest rates have fallen to near record lows. "Long term rates are now so low that people are asking how they can get out of their interest-only loans and into fixed-rate long-term loans," said Mitch Ohlbaum, an L.A.-based mortgage broker.
*The full story will be available in the July 4 issue of the Los Angeles Business Journal.
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