by Calculated Risk on 10/27/2005 04:57:00 PM

IBD reports: Data confirm increased use of 'creative' mortgages

Faced with rising interest rates, more U.S. home buyers sought savings by opting for riskier nontraditional mortgages in the early part of this year compared with late last year, more evidence of a trend that has caught the attention of regulators and the mortgage industry at large, Mortgage Bankers Association data released Tuesday showed.
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Mortgage activity overall expanded in the early part of this year: the dollar volume of first-mortgage originations on single-family homes increased 10%, while volume for second mortgages rose 12%, the trade group said as part of its annual conference, held in Orlando, Fla.
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"With the difference in ARM rates and fixed rates narrowing, consumers have shifted from traditional ARMs to nontraditional products," said Doug Duncan, MBA's chief economist.
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The increase in nontraditional lending prompted the Federal Reserve earlier this year to urge greater vigilance on the part of mortgage lenders too.

The Fed's attention highlighted the growing risk in this area, although some of that risk is countered by the large amount, more than half, of loans locked in at fixed interest rates.

The most popular of the "creative" financing now being undertaken by some households include interest-only loans and option ARMs, a relatively new product that allows borrowers to choose each month to pay interest only, interest plus some principal, or even less than the interest due, with the remaining portion of the interest payment tacked on to the principal.

A Wells Fargo survey released this week showed most holders of these loans were paying toward principal. But some experts said the real test will come in just over a year, when higher interest rates kick in for these loans. See related story.

Interest-only loans increased to a 23% share in the first part of this year from a 17% share late last year, the MBA poll showed.

Option ARM originations rose to 7% of the dollar value of originations and 4% of the loan count during the first half of 2005.

"These percentages are likely understated as many survey respondents did not report their option ARM volume," the group said.

Originations of loans to consumers with riskier credit ratings also increased, the survey found. The share of originations that were so-called Alt-A loans, or those that fall somewhere on the risk spectrum between prime and subprime, increased to 11% from 8%.

The survey also found that the majority of loans, 88% in the first half, were for owner-occupied homes. But a rising share was taken up by loans for non-owner-occupied properties, at a "significant" 12%, MBA said.

Some market observers have said that mortgage risk overall has risen in step with an increase of mortgages on investment property. Traditionally, homeowners are viewed as more likely to keep up with payments on their own residence, less so on the roof not over their head.

Here is the MBA release: Mortgage Originations Rise in First Half of 2005; Demand for Interest Only, Option ARM and Alt-A Products Increases

*More than 9 of 10 interest only loans originated during the first half of 2005 are adjustable rate products, the remaining loans were fixed rate products.

*Among all survey respondents, option ARM originations were 7 percent of dollar originations and 4 percent of the loan count during the first half of 2005. These percentages are likely understated as many survey respondents did not report their option ARM volume. Among survey respondents that did report option ARM data, option ARM loans comprised 16 percent of their dollar originations and 10 percent of their loan count.

*The vast majority of loans (88 percent) in the first half were for owner occupied homes, but the percentage of loans for non-owner occupied properties was significant (12 percent). This finding is consistent with the 2004 Home Mortgage Disclosure Act data which revealed that more than 11 percent of 2004 originations were for non-owner occupied properties.

*While nearly half (48 percent) of all loans originated were agency eligible, they represented only 38 percent of the origination dollar volume. Agency eligible loans are mortgage loans which conform to the size and credit quality guidelines and would be available for sale to Fannie Mae and Freddie Mac under any of their loan programs.

*From the second half of 2004 to the first half of 2005, reverse mortgage originations increased 28 percent, with FHA’s Home Equity Conversion Mortgages (HECMs) increasing by 31 percent and other reverse mortgages up 8 percent.

*Compared with the last half of 2004, the first half of 2005 origination volume of all second mortgages increased 12 percent, closed-end seconds increased 37 percent and open-end seconds or home equity lines of credit (HELOCs) increased 20 percent (based on companies submitting data for both time periods).

*In the first half of 2005, 82 percent of second mortgage originations were HELOC loans compared with 18 percent for closed-end loans. HELOC origination volume refers to the size of the line, not the drawn amount.