IO, 100% & Investor Loans Concern Economists

Frank Nothaft, chief economist from Freddie Mac, joined four other prominent housing economists Wednesday in a biannual forecast conference call sponsored by the Homeownership Alliance, a Washington, D.C.-based group that says its membership includes community bankers, housing groups and consumer advocates.

The group’s consensus called for 2005 to be another record year for the housing industry as a result of population and job growth and low mortgage rates, which are lower than previously anticipated.

Nothaft said he expects the 30-year to end the year close to 6% and that short-term rates would follow. Predictions for the federal funds target rate, currently at 3%, were 3.5% on the low end to as high as 4.25%.

Nothaft expects total originations this year will be $2.4 trillion, while economists David Berson from Fannie Mae and David Lereah of the National Association of Realtors believed the magic number would be $2.6 trillion — which, in either case, represent a decline from last year.

Nothaft predicted refinances would decline to make up 40% of the annual volume — the lowest level in five years — and that adjustable-rate mortgages will account for about one in three originations.

Fannie’s Berson said he was concerned about the high level of investor activity in home sales because, if the economy were to slump, many would dump many houses back into the market. Nationally, investor and second home investor share of purchase originations is around 15 to 17 percent, Nothaft said.

The consensus on interest-only loans was that they did represent greater risks because of potential shock once the payment adjusted. Some of the group were more concerned about so called negative amortization loans, in which the interest rate is reduced and causes loan balances to grow rather than decline.

The push “to ARMs, IOs and negative amortization loans is helping blunt interest-rate shock,” Lereah said. “When you have long-term fixed mortgage rates hovering near historic lows, that does make us nervous. Its not a healthy situation.”

IO loans are “a serious problem” for those who rely on these products to stretch and be able to afford a home, Lereah said, suggesting that regulators and lenders be cautious in how they market IO and negative amortization loans to avoid putting unsophisticated borrowers in these loans without knowing the risks.

In San Diego, 47% of loans made were IO, while in Atlanta the percentage was 45, Lereah said, “startling results” to the extent that IOs are interest only for the first couple of years and “then they blow up on you.”

But Nothaft did say that automated underwriting systems are a factor in mitigating risks of such loans as they provided consistency in underwriting and evaluating risks.

David Seiders of the National Association of Home Builders noted, however, that brokers — not banks or secondary lenders — in many cases package the unconventional loans into pools and sell these to investors, who may or not understand the risks in such pools.

Paul Merski, economist for the Independent Community Bankers, sees the “whole discussion of how dangerous all these ARM products are and interest only as being well overblown.” He contended that IO loans are not much different than 30-year fixed rate loans as the latter loan has very little principal paid in the first years. Plus, many adjustable-rate loans have initial set periods of five to seven years, “so its not like overnight people are going to be thrown into a rapid increased mortgage payment.”

More troublesome are the zero or low downpayment loans, which have historically had a higher default rate, he added. Even so, such loans represent only about 5 to 7 percent of the lending market.