But are they really extinct? Or have they simply gone into hibernation, waiting to emerge again when the economic climate is once again favorable for them? While some of these truly seem to be gone for good, others have simply retreated to a specific niche in the market. And still others are beginning to re-emerge after a period of dormancy.
Here’s a look at some of the better known “extinct” mortgages, along with what mortgage professionals have to say about their current status.
1. Stated Income
Why? Because stated income loans have long been popular with self-employed individuals who maximize the deductions on their tax returns, or who have substantial assets but whose income varies from year to year. As a result, their tax returns may not give a full picture of their financial state.
“You may have a doctor who has $500,000 in income but only $50,000 on his return,” said Bruce Spector, a loan consultant with Summit Funding in Reno, Nev. “So that’s great at tax time, but when it comes to qualifying for a mortgage, they can’t do that.”
A stated income mortgage allows such people to qualify on just their credit rating and assets, along with the appraised value of the property.
Spector said stated income loans are making a comeback because, in today’s “yield-starved environment,” where CDs and bonds are typically paying less than 1% interest, some investors are turning to privately funded mortgages in hopes of getting better returns on their investments.
“They’re looking for returns, they’re willing to take that risk,” he said. “There’s money in that, so they’re willing to look at the non-traditional mortgages.”
2. No Money Down
It was pretty common to be able to buy a home with no down payment during the first half of the last decade. Some lenders simply didn’t require them and you could even get a no-money-down conforming mortgage backed by Fannie Mae or Freddie Mac by taking out a “piggyback” loan to cover the down payment. These days, zero-down-payment mortgages are almost impossible for most borrowers to get. However, they’re not completely gone. You can still get a no-money-down mortgage through the VA if you’re a qualifying veteran or active-duty member of the military. Also, borrowers with low-to-moderate incomes may be able to get a USDA Rural Development loan with no money down to buy a modest home in a rural area or small community.
Though zero-down-payment mortgages are still hard to come by, it’s becoming much easier to get a mortgage with a small down payment. In fact, it’s even possible now to get a conventional mortgage with only 3% down without going through the FHA, according to Richard Whitman, vice president of mortgage lending for Texas Trust Credit Union. That’s because mortgage insurers are becoming more comfortable with insuring those loans, he said.
“If you’ve got a good credit score with 3% down, the [private mortgage insurance] isn’t that bad,” Whitman said, referring to the private mortgage insurance (PMI) required on conventional loans with less than 20% down. Whitman said you can still get a 3% down Fannie/Freddie-type mortgage even with a credit score in the 660-680 range these days, although the PMI will be fairly costly to someone with a score of 720 or better. But increasing the down payment to 5% will reduce the cost of PMI significantly, he said.
These days, virtually no lender will let you buy a buy a home with an interest-only mortgage. There is, however, one place where interest-only loans are still found – in home construction. Builders will take out a short-term interest-only loan to cover the cost of construction, which will then be converted to a fully amortizing loan when the home is completed and transferred to a new owner. “Those have always made sense for investors who wish to keep costs low during the first part of the loan, tie up as little money as possible,” said Summit Funding’s Spector.
4. Negative Amortization
Going even beyond interest-only mortgages were negative amortization loans. On these mortgages, it wasn’t even a requirement to keep up with the interest payments – a borrower’s monthly payment could be less than the interest charges, meaning that the mortgage balance, the amount owed on the loan, would actually increase – negative amortization. The most common of these were Option Adjustable-Rate Mortgages, sometimes referred to as “pick-a-payment.” With these, the borrower could opt for a monthly payment that was less than the underlying interest charges, digging themselves further into debt as time went on.
DeBord described Option ARMs as “the ultimate boom loan” and “a terrible loan for the average homeowner,” but a potentially good one for savvy investors to use for short-term projects where they wanted to minimize their cash outlay. He said he’s only written one such loan in his entire career, for a multi-million dollar property where the owner wanted to keep his assets free during a remodel and paid it off shortly afterwards.
“If the Neg-Am had only been offered to highly-qualified borrowers, it wouldn’t have been a bad product, but it was too complicated for the average homeowner and many made bad decisions in using it,” DeBord said. After getting burned so badly on them in the downturn, it doesn’t appear that lenders will be offering these types of loans again any time soon.
ARMs are a type of loan that may seem to have disappeared after being wildly popular during the housing bubble years. In reality, they’re still very much alive, though much less common than they used to be. However, some of their variations that were very common during that time – such as the Option ARM discussed above – have disappeared to the point where they are pretty much extinct.
Demand for ARMs has shrunk dramatically since the crash, but not necessarily because people viewed them as inherently risky. It’s because the rates on fixed-rate loans dropped so low that ARMs had trouble competing.
Even so, ARMs still occupy a small slice of the market because of the advantages they offer a certain type of borrower. “Over the last few years, we’re seeing a bit of the ARMs coming back, particularly 5/1 ARMs, for people who aren’t planning to stay in the home for more than a few years,” said TCU’s Whitman.
He said the loans are coming back in vogue for those borrowers because it doesn’t make sense for them to lock in a long-term loan. Instead, they can get an ARM whose initial term matches the length of time they expect to stay in the home and save a bit on interest.
6. Teaser Rates
What got people into trouble with ARMs wasn’t necessarily the fact the loans were adjustable, but some of the features that were often combined with them. One of the most common of these was the “teaser” rate, where borrowers would start out with a very low rate, but the loan would later reset to a much higher rate.
Because these tended to be sold to borrowers who were poor credit risks, they easily got into financial trouble when the “teaser” rate ended and their payments increased. But the banks made enough off the loans to offset the high default rate, at least while home values were still rising.
But that all changed once home prices began to fall and the default rate increased.
“The whole subprime market started melting down, the lenders starting losing money hand over fist, like wildfire,” Walters said. “It was like a switch flipped.” Walters said the basic rule of lending is that if the reward outweighs the risk, the borrower gets the loan. It’s still that way today, he said.
“It’s just after the housing bubble burst and the meltdown, they just know those loans don’t perform any more,” he said. “The bottom line is, those things aren’t coming back, probably never.”
7. Balloon Mortgages
Somewhat akin to ARMs are balloon loans. These are where a borrower gets a loan at a low rate for a certain number of years, often seven, with payments based on a longer amortization, say 30 years. But at the end of the seven years the entire remaining balance comes due, hence the name balloon.
Like ARMs, balloon mortgages tend to offer lower rates than comparable fixed-rate mortgages and for the same reason – the lender doesn’t have to worry about being saddled with a low-rate mortgage long-term if rates rise in the future. They’ve also fallen out of popularity for the same reason as ARMs – because rates on fixed-rate mortgages have been so low there’s not much advantage to them.
“Those are still out there, but they’re just not practical right now, he said, noting that balloon loans work best in an environment where rates are likely to decline.
“No mortgage person worth their salt thinks rates are going to go down,” Palzkill said.
As for truly extinct mortgage types, Palzkill doesn’t think there are truly that many of them. Risk is coming back into the market, he said, people want to borrow money and investors will lend it to them if they can make a profit.
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