The Consumer Federation of America appears to share the concerns of some housing industry experts and regulatory agencies about the proliferation of so-called "exotic" mortgage products in the marketplace.
Data collected by the federation indicate that these "riskier" mortgages are falling on middle and moderate income borrowers with less-than-stellar credit scores.
An analysis of that data found that African Americans and Latinos were more likely than whites to take out payment-option and interest-only mortgages.
"While the lending industry has characterized non-traditional borrowers as financially sophisticated and savvy consumers, the truth is that many are far from affluent and could be betting the house on their mortgage," said the federation's Allen Fishbein. Because home ownership is so critically important in financial security, these Americans are unwittingly putting their entire financial livelihood at risk, he said.
Mortgage Bankers Association chief economist Duncan Douglas recently said half of those holding so-called "exotic" mortgages were high-income and could handle fluctuations in rates.
Yet, despite opposition from the MBAA and other lender organizations, the Comptroller of the Currency and other agencies have proposed guidelines that would effectively limit concentrations of these mortgages in certain geographic areas.
The concern among housing-industry officials and regulators is that a large concentration of these loans in the highest-priced real estate markets could result in a tidal wave of defaults and foreclosures - and a highly regionalized "bubble."
The consumer federation maintains that while the number of available loan products has proliferated over the last few years, there is little understanding by many borrowers about how to compare or even understand the differences between them.
In its study, "Exotic or Toxic? An Examination of the Non-Traditional Mortgage Market for Consumers and Lenders," the federation analyzed borrower and loan characteristics of more than 100,000 mortgages originated between January and October 2005.
Among the key findings:
Significant shares of nontraditional borrowers earn less than $70,000 annually. More than one third of interest-only borrowers had annual incomes below $70,000, and about one in six earned under $48,000 a year.
More than a third of payment-option borrowers earned under $70,000 annually, and about one in eight made under $48,000. The $70,000 median is for the Atlanta, Philadelphia and Chicago metropolitan areas, according to HUD figures for 2005. The national median is $44,300.
African Americans and Latinos are more likely to receive payment-option mortgages. Latinos are nearly twice as likely as non-Latinos to receive payment option mortgages. One in 50 non-Latino borrowers received payment-option mortgages, compared with the 4 percent of Latinos who received payment-option mortgages. African Americans were more likely than non-African Americans to receive payment-option mortgages.
African Americans were more likely than non-African Americans to receive interest-only loans. Nearly one in 10 of African Americans received interest-only mortgages, 8.1 percent of non-African Americans that received interest-only mortgages.
Many nontraditional borrowers have only average or even weaker credit scores. More than half of payment option borrowers and nearly two-fifths of interest-only borrowers have credit scores below 700. More than one fifth and about one in eight interest-only borrowers had credit scores below 660.
The majority of these two types of nontraditional mortgages are used to purchase homes. Nearly four out of five interest-only mortgages and nearly three fifths of payment-option loans were used to finance the purchase of a home.
The federation's research found that although these borrowers broadly have higher incomes and credit scores than borrowers overall, many have incomes and credit scores considerably below this.
Many borrowers are increasingly relying upon non-traditional mortgages as a means to buy homes they could not otherwise afford.
Nontraditional mortgage products typically offer initial lower monthly payments than traditional fixed-rate loans. But when these loan terms reset after a brief period, usually two to five years, consumers could be vulnerable to payment shocks, making their homes suddenly unaffordable and potentially ruining their finances.
A $200,000 home with an adjustable rate non-traditional mortgage, an interest-only adjustable payment would rise by 54 percent, and a payment-option adjustable would rise by 123 percent, if the interest rate rose from 5 percent to 6.50 percent.
Nontraditional mortgage products may benefit certain consumers, but pose more risks than benefits for many others, according to the federation. There are indications that many borrowers do not fully understand that these mortgages expose borrowers to potentially sharp increases in borrowing costs.
"The plain fact is that deferred payment mortgage products simply may not be appropriate for all borrowers who receive them and therefore, a threat to homeownership sustainability," the consumer federation said.
