Is it ethical for real estate and mortgage brokers to ignore the inherent risks of so-called exotic mortgages in order to help more people buy their own homes? The answer, arguably, is no.
Granted, higher house prices and mortgage interest rates have made home-buying much more difficult in recent years, and it would have been impossible for many new homeowners to have bought a home without some of the more creative loan products that are now available. It’s no surprise that these mortgages have become quite popular, even though borrowers who can’t manage to make the higher payments in later years face a financial crisis and potential loss of their home.
Two examples of these newer, nontraditional mortgages are interest-only and payment-option loans. An interest-only mortgage defers payment of any principal for an initial term after which the monthly payment is adjusted to amortize the loan over the remaining term. A payment-option mortgage allows the borrower to select a from among a number of monthly payments some of which may result in negative amortization.
Home buyers, like all adults in every respect, are responsible for their own financial decisions and the consequences of those decisions, be they good or ill. Purveyors of these products might argue that borrowers are entitled to obtain a risky mortgage if they desire to do so, even though these products entail more risk than a conventional mortgage and require a high degree of financial acumen to understand.
Yet likewise, buyers should be able to rely on trusted professionals for information, education, advice and good counsel because, after all, professionals are in a strong position to know what’s reasonable and what’s excessively risky. Moreover, professionals have an ethical obligation to utilize their own experience and expertise to help their clients make choices that are in the clients’–and not just the professionals’–best interest. It’s difficult to argue that “helping” people buy a home they can’t afford to own is in their own best interest.
A new Consumer Federation of America report, “Exotic or Toxic? An Examination of the Non-Traditional Mortgage Market for Consumers and Lenders,” found that a high percentage of some of the most esoteric mortgage products, specifically, the interest-only and payment-option mortgages, is being sold to people who aren’t in a position to take on the higher level of risk that’s inherent in these financial instruments.
The study, which analyzed the characteristics of more than 100,000 mortgages originated in 2005, found that moderate-income borrowers with lower-than-average credit scores were the primary users of interest-only and payment-option mortgages.
More than a third of the borrowers who obtained these mortgages earned less than $70,000 annually and roughly 12 percent-15 percent earned less than $48,000 annually. Even more worrisome, substantial percentages of these borrowers had credit scores lower than 700, and significant numbers of them had credit scores lower than 660.
Given just how complicated and risky these esoteric loans are, could they in any respect be appropriate for people who earn less than $40,000 a year and have credit scores of less than 660? These are not wealthy people, and it’s unlikely that they have the substantial financial resources that would cushion the risk. It also seems unlikely that they have the financial knowledge, discipline and experience that, again, would enable them to weather the risk of these mortgages over the long haul of home ownership. It’s just not ethical to “help” people buy a house they really can’t afford to own. In such cases, these mortgages destroy the financial benefits of home ownership and set up new homeowners for future losses and hardship.
The Consumer Federation of America study also analyzed the percentages of these loans that have been made to African American and Latino home buyers and suggested those percentages were unreasonably high. These analyses may be of interest, but they aren’t as meaningful to the point as the income and credit score findings. Better still would have been some analysis on the basis of house prices and geography to ascertain whether these loans are concentrated in affordable or low-income neighborhoods.
Esoteric high-risk mortgages don’t help priced-out home buyers nearly as much as they help hungry mortgage brokers, who earn a commission from the deal, and lenders, who earn mortgage origination fees and force the borrowers to pay for mortgage insurance that protects the lenders’ interest. Where will the unethical broker and lender be when the homeowner can’t make the mortgage payments and doesn’t have enough equity to afford the substantial costs of selling the home?
Of course every homeowner’s situation is unique and there are always exceptions to the overall premise. Yet the notion (to borrow from Alfred Lord Tennyson) that it might be better to have owned and lost than never to have owned at all doesn’t do justice to the financial and emotional harm of these unethical practices.
Marcie Geffner is a real estate reporter in Los Angeles.
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