While the use of so-called “exotic” or “nontraditional” mortgage loan products has soared during the housing boom, new research suggests that middle and moderate income borrowers with less-than-stellar credit scores are carrying the brunt of these riskier loans.
An analysis from the Consumer Federation of America found that African American and Latinos were more likely to receive payment-option mortgages than whites and African Americans were more likely to receive interest-only mortgages.
The new research findings appear in the group’s newly released study, “Exotic or Toxic? An Examination of the Non-Traditional Mortgage Market for Consumers and Lenders.”
The report, which analyzed certain borrower and loan characteristics of more than 100,000 mortgages originated between January and October 2005, examines the implications of the rapid rise of non-traditional mortgages and how these products pose additional risks for borrowers.
Nontraditional mortgage loans such as interest-only and certain adjustable-rate mortgages have become popular over the last few years as soaring home prices made it more difficult for consumers to afford homes. Though such loans often served the purpose, they have come under criticism from federal officials including then-Federal Reserve Chair Alan Greenspan and the Comptroller of the Currency.
The consumer watchdog group says that there is little understanding by many borrowers about how to compare or understand the differences between these loan products.
“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,” Allen Fishbein, director of credit and housing policy at Consumer Federation of America, said in a statement today.
Among the study’s key findings:
- Significant shares of non-traditional mortgage borrowers earn less than $70,000 annually: More than one third (36.9 percent) of interest-only loan borrowers earned below $70,000 annually and about one in six (15.6 percent) earned under $48,000 annually. More than one third (35 percent) of payment-option borrowers earned under $70,000 annually and about one in eight (12.1 percent) earned between under $48,000. ($70,000 was about the median for Atlanta, Philadelphia and Chicago metropolitan areas, according to HUD figures for 2005, and 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 (2.1 percent) non-Latino borrowers received payment-option mortgages compared to the 4 percent of Latinos that received payment-option mortgages. African Americans were 30.4 percent more likely than non-African Americans to receive payment-option mortgages. 2.2 percent of non-African Americans received payment-option mortgages compared to 2.9 percent of African Americans.
- African Americans were more likely than non-African Americans to receive interest-only loans: Nearly one in 10 (9 percent) African Americans received interest-only mortgages, 11.7 percent higher than the 8.1 percent of non-African Americans that received interest-only mortgages.
- Many non-traditional borrowers have only average or even weaker credit scores: More than half (53.8 percent) of payment-option borrowers and nearly two-fifths (38 percent) of interest only borrowers have credit scores below 700. More than one fifth (21.4 percent) and about one in eight (12.1 percent) interest only borrowers had credit scores below 660.
- The majority of these two types of non-traditional mortgages are used to purchase homes: Nearly four out of five (79 percent) interest-only mortgages and nearly three fifths (57.5 percent) of payment-option loans were used to finance the purchase of a home. The high proportion of purchase mortgages in the non-traditional mortgage portfolio tends to support the contention that the increased use of these mortgage products is related to the rapidly escalating cost of housing.
Although these borrowers broadly have higher incomes and credit scores than borrowers overall, the consumer group says that many have incomes and credit scores considerably below this.
Many borrowers increasingly rely on non-traditional mortgages as a means to buy homes they could not otherwise afford, CFA said. Non-traditional mortgage products typically offer initial lower monthly payments than traditional fixed-rate loans. But when these loan terms reset after a brief period, usually 2 to 5 years, consumers could be vulnerable to payment shocks, making their homes suddenly unaffordable and potentially ruining their finances.
“Non-traditional mortgages are more complex than your parents’ home loan, and some highly leveraged or unsophisticated consumers could end up learning that the mortgage that helped them buy their home was a ticking time bomb that destroyed their finances for years,” said Patrick Woodall, CFA’s senior researcher.