by Calculated Risk on 10/10/2005 12:44:00 PM

The LA Times has another great article: Risky 'Exotic' Loans Fostering a Refi Cycle

Craig Wolynez is the kind of homeowner stoking fears about a housing bubble.

Even though he had no steady income, the 33-year-old computer consultant and his wife were able to purchase a $416,000 house in the San Fernando Valley two years ago using an "interest-only" mortgage that guarantees low monthly payments for the first five years. After that, Wolynez's payments could rise sharply — making him a prime candidate for default or, even worse, foreclosure.

But like many financially stretched home buyers, Wolynez has a way out: He plans to refinance before his payments balloon. He's now shopping for a new interest-only mortgage that will keep his payments manageable longer.

"There's an urgency," he said. "We know we have to refinance."

Countless home buyers like the Wolynezes sign up for risky mortgages knowing full well they plan to refinance them — or sell their homes — before the payments go up.

And lenders are catering to these marginal buyers:

The mortgage industry not only grasps this refinancing game, it aggressively markets new loans to these borrowers, raking in additional profits from fees and other charges. And lenders continue to devise more creative loans that reduce payments further and extend purchasing power in pricey markets such as California.

"Lenders are putting people into loans where they are almost guaranteed to be refinanced," said George Yacik, vice president of SMR Research Corp., a Hackettstown, N.J.-based financial research firm.

This may work in the short term:

Over time, repeated refinancings could increase the risks of a more severe slump. Already, many fear that homeowners with interest-only mortgages will find themselves "underwater" — owing more than their homes are worth — if prices soften. For the borrower who has refinanced repeatedly, the amount of the debt is likely to be even greater, particularly for those who converted their equity into cash with each new loan or who have paid little or no principal.

Homeowners' ability to continually swap interest-only mortgages not only keeps their payments low for a longer period, it delays the day of reckoning when principal becomes due. As long as home values keep rising, borrowers are protected from becoming overextended.

"So far it's worked out well because they've been able to refinance their way out of trouble," said Keith Gumbinger, vice president of mortgage information publisher HSH Associates.
...
"I don't think refinancing is something people should be doing frequently," said Dean Baker, co-director of the Center for Economic and Policy Research in Washington. "In a falling interest-rate environment you may be saving enough to make it worthwhile. But the mortgage could go bad in the future."

"So far its worked out well ..." So far.