California homebuyers have greatly benefited from a variety of nontraditional mortgage loans that made an otherwise unaffordable housing market affordable. Over the past three-or-so years, prices soared in Los Angeles County and homes quickly became unattainable under the terms of conventional, fixed-rate mortgages. Lending institutions responded by offering nontraditional mortgages such as interest only and adjustable rate. With many pushing reduced payment options that were less than full interest payments, some homeowners saw an increase in their loan balances. The bet was that the equity would increase more quickly than the balance.
Now times are changing. The real estate market, which was seeing an almost double-digit increase in home values, is now slowing and, for the first time this year, home prices may start to drop. Homebuyers who took advantage of creative financing on the assumption their equity would increase so they could later refinance to a conventional loan are now in a quandary: What helped some Angelenos buy a house may now hurt them financially as they find their payments or even principal balances increasing.
But concerns don't stop there. Borrowers are also learning that the loans they qualified for were not the best fit for their financial profiles. For example, a person qualifies for a loan with a teaser rate of 3 percent or a payment rate of 1 percent. Soon the teaser rate turns into a fully indexed 6 percent rate for a borrower who could only qualify at 3 percent. Or the loan balance increases because the payment rate is actually less than a full interest-only payment.
Before you know it, the borrower is left with a nearly impossible payment or a much higher loan balance than was originally borrowed.
What happens now? Some homeowners will stretch themselves to the limit in order to make their house payments, and some will inevitably succumb to foreclosures. This scenario should be of major concern for those of us who lend in Los Angeles County.
To help remedy this, federal regulators recently announced guidance standards requiring financial institutions to more fully disclose the risks of nontraditional loans in writing. Is this enough?
The truth of the matter is that much more should be done voluntarily to help borrowers through the financial and legal jargon that rattles even the most knowledgeable homebuyers. And yes, this means that those of us in the financial community need to provide sound financial advice in the best interest of the borrower.
Advertising and disclosure
Why do borrowers agree to these nontraditional and sometimes risky loans? Bottom line: It's advertising and disclosure. Since lenders are required to disclose the risks involved with nontraditional loans (albeit in fine print), you would think that borrowers are fully educated on these risky loans. But this just isn't the case. Advertisers are able to devote the bulk of an ad to promoting the great introductory rate, and leave the risky business in the very fine print of a newspaper ad or the mile-a-minute disclaimer at the end of a radio commercial.
In fact, it almost seems that there is a conscious effort in many advertisements not to disclose such risks. Many borrowers don't take the time to read the fine print and instead focus their priorities on affording their home now and worry about the rest later. If the big-print advertising says you can afford your new home, it must be true. And lenders aren't obligated to volunteer the risk information verbally to ensure a total understanding by the homebuyer.
Though the existing as well as new disclosure standards apply to lenders nationwide, the question is whether lenders are confusing borrowers by operating in the gray areas that may not violate the letter of the law but certainly violate the spirit and intent of regulations and guidelines. Until disclosures are clear, it's tough for consumers to discern a clever ad from an actual good rate, and consumers will continue to be drawn to lenders who are not inclined to fully inform the borrower.
Many of those loans need to exist in order for people to buy homes. We need to make sure they're marketed to a homebuyer who's in a position not only to afford a home now, but also in the future.
Gary Hails is the vice president of lending at Los Angeles-based Pacific Resource Credit Union. He is also a member of the Credit Union Executive Society.
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