Monday, July 20, 2015

A comment on Interest Only Mortgage Loans

by Bill McBride on 7/20/2015 02:07:00 PM

Some people incorrectly blame "subprime" for the financial crisis. Others blame interest only loans. Neither are toxic if underwritten correctly.

From Diana Olick at CNBC: Interest-only mortgages: They're baaack

They were the villains of the housing crash. Federal regulators called them toxic. Now interest-only mortgages are making a comeback, but these are not the loans of yesteryear or yester-housing booms.

"I think it's opening the door back to responsible lending, giving people choices," said Mat Ishbia, president and CEO of Michigan-based United Wholesale Mortgage, the second-largest lender through brokers in the nation.

The company announced Monday it is now offering interest-only loans through brokers, with significant safeguards. Borrowers must put 20 percent down, ensuring that they have the "skin in the game" that so many did not during the heady days of the housing boom. They must have at least a 720 FICO credit score, which is well above average, and they must qualify on what the payments will be once they're adjusted higher, not at the starter rate.
There were several problems with mortgage lending in the mid-2000s. There was widespread use of subprime and Alt-A loans with risk layering. Risk layering might have included qualifying at a teaser rate, 100%+ loan-to-value financing, negative amortizing loans, interest only, and/or, self-underwritten loans - so-called stated income loans.

A subprime or interest only loan, underwritten properly, is a reasonable mortgage product (such as described in the article).  However if the lender starts layering risk, then the product could be dangerous.

If you want to understand Subprime and Alt-A, here are two great posts from my former co-blogger Tanta:

What Is "Subprime"?

Reflections on Alt-A