by Calculated Risk on 10/04/2005 11:54:00 AM

The Mercury News has an excellent series of articles called "Unreal Estate". Today's article is Part III: Loan landslide on shaky soil

The previous articles in the series:
Part I: Housing boom showing its age
Part II: How the boom has hit home
Also see the companion articles in the side bar.

Excerpt from Part III:

Almost overnight, a transformed mortgage industry has rewritten the rules for home-buying. Relying on improved credit scoring, better risk-analysis tools and abundant cheap capital from around the globe, lenders have flooded the market in the past two years with exotic loans that allow consumers to take on more debt and more risk. People who once would have been denied mortgages now get the chance to join the auction and bid up home prices.

Such loans are particularly popular in Silicon Valley, helping to push prices at a double-digit pace that many experts worry is unsustainable.

Interest-only loans, for example, accounted for more than half the purchase loans in the Bay Area in the first quarter of the year. That's nearly five times higher than in 2002, says LoanPerformance, a San Francisco firm that analyzes mortgage trends. And piggy-back loans -- which package two loans for borrowers putting less than 20 percent down -- accounted for about 60 percent of the loan volume in the Bay Area in the first half of 2005, according to SMR Research, a financial-services market research firm in Hackettstown, N.J.

But while exotic loans have swelled the ranks of potential buyers, slowing homes sales this summer are fueling worries about the economic aftershocks if the real estate market cools or slumps.

And for a description of some of the risky mortgage products available today, see Schwanhausser's companion article: The lowdown on loans

• Adjustable-rate loans with tantalizing "teaser" rates: Some ARMs dangle introductory interest rates as low as 1 percent. But beware: Some ARMs begin to adjust within as little as a month and can ratchet higher rapidly. That can lead to "payment shock."

• Hybrid ARMs: They start out like fixed-rate loans, charging the same flat monthly payment of principal and interest. After three to seven years, typically, they turn into adjustable-rate loans. The payment shock can be substantial if interest rates rise.

• Interest-only loans: Borrowers may pay only the interest portion of the monthly payment, typically for three to five years but sometimes up to 10 years. After that, the monthly payments can vault higher to pay off the principal over the remainder of the loan.

• Option ARMs: Every month borrowers get to choose from a handful of payment options. When times are flush, they can pay what they would owe under a standard 15- or 30-year fixed-rate mortgage. Or they can just pay the interest. But if cash is tight, they can make a minimum payment that is less than the interest charge.

The last option can result in "negative amortization" that leaves homeowners owing more than they borrowed in the first place. Also, monthly payments can jump after a number of years or if the negative amortization exceeds the "cap" allowed by the loan.

• "Piggyback" loans: This is an increasingly popular tactic that involves packaging two loans to avoid the hefty monthly bills for private mortgage insurance, or PMI, that is required when borrowers make a down payment of less than 20 percent. For example, lenders often package one mortgage for 80 percent of the home's value with a home-equity loan or line of credit for the remaining 20 percent.

Also the NY Times continues their reporting on the housing market: Slowing Is Seen in Housing Prices in Hot Markets and Home Builders' Stock Sales: Diversifying or Bailing Out?