November 2005

Volume 6 Issue 10 November 2005

Housing and Mortgage News

Greenspan Addresses Creative Financing Trends

While 80 percent of DWM survey respondents say they are aware of the rising trend of interest-only mortgages, a whopping 72 percent of those say they are worried what effect these will have on the housing industry. Everyone seems to be concerned about the crop of creative mortgage options that have emerged in recent years, including Federal Reserve Chair Alan Greenspan. In fact, when he addressed the American Bankers Association at its Annual Convention on September 26, 2005, Greenspan addressed the key factors driving the U.S. economy in recent years including the sharp rise in housing valuations and the associated buildup in mortgage debt.

“This enormous increase in housing values and mortgage debt has been spurred by the decline in mortgage interest rates, which remain historically low. Indeed, the 30-year fixed-rate mortgage, currently around 5-3/4 percent, is about 1/2 percentage point below its level of late spring 2004, just before the Federal Open Market Committee embarked on the current cycle of policy tightening. This decline in mortgage rates and other long-term interest rates in the context of a concurrent rise in the federal funds rate is without precedent in recent U.S. experience.”

He also noted that the low level of home mortgage interest rates has been a major driver of the recent surge of homebuilding and home turnover and the steep climb in home prices.

“The apparent froth in housing markets may have spilled over into mortgage markets. The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other, more-exotic forms of adjustable-rate mortgages, are developments that bear close scrutiny. To be sure, these financing vehicles have their appropriate uses. But to the extent that some households may be employing these instruments to purchase a home that would otherwise be unaffordable, their use is adding to the pressures in the marketplace.”

Greenspan also addresses the plethora of loan choices now available. In addition to interest-only options, some of those mentioned by Greenspan include:

· 40-year amortization schedules and adjustable rate mortgages. These allow for a limited amount of negative amortization, according to Greenspan. “These products could be cause for some concern both because they expose borrowers to more interest-rate and house-price risk than the standard 30-year, fixed-rate mortgage and because they are seen as vehicles that enable marginally qualified, highly leveraged borrowers to purchase homes at inflated prices. In the event of widespread cooling in house prices, these borrowers, and the institutions that service them, could be exposed to significant losses.”

· Piggyback mortgages; second liens originated at the time of purchase. These loans are popular, says Greenspan, because they avoid the non-deductible private mortgage insurance payments required on larger, single loans. “If piggyback loans are more common in states in which house price appreciation has been particularly rapid over the past five years, one might worry that homebuyers are especially exposed to reversals in house prices. However, data collected for 2004, the first year of coverage in HMDA, show that the use of piggyback loans was not particularly correlated with strong appreciation of prices.”

· Of course, the HMDA data do not track mortgages made by all institutions or open-ended loans such as home equity lines of credit (HELOCs). Anecdotal reports suggest that some homebuyers are using HELOCs as piggyback mortgages, and so we probably do not have a full accounting of all mortgage debt.

· Long-Term Variable (LTV). Greenspan says these are highest in states that have experienced relatively little house price appreciation, and lowest in states in which prices have appreciated the most, such as California and Massachusetts. “The main reason for this negative relationship is likely that most people buying a home in California are probably also selling a home in California and using at least part of their accumulated home equity capital gains as a down payment on their new house.”

While it may seem that the picture looks bleak, Greenspan ended his speech with some encouraging comments.

“Despite the rapid growth of mortgage debt, only a small fraction of households across the country have loan-to-value ratios greater than 90 percent. Thus, the vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices. In addition, the LTVs for recent homebuyers appear to be lower in those states that have experienced the most explosive run-up in house prices and that, conceivably, could be at risk for the largest price reversal. That said, the situation clearly will require our ongoing scrutiny in the period ahead, lest more adverse trends emerge.”