Low-payment mortgages harder to get

In recent years, mortgage lenders have offered more financing options than ever before. Homeowners today can find a loan that suits almost any financial situation and tolerance for risk. New federal guidelines, however, may make some of these mortgage options less common.

The nation’s financial regulatory agencies have proposed guidelines aimed at “nontraditional mortgages.” In particular, the agencies pointed to interest-only mortgages and the type of adjustable rate mortgages known as an option-ARMs or flex-ARMs, which they feel pose a higher risk to both homeowners and the financial community.

With an interest-only mortgage, a homeowner pays just the interest owing every month for a fixed period -- usually three to five years. Then, depending on the term of the loan, the borrower has 20 to 25 years to repay the principal, plus interest. An option-ARM gives the homeowner a choice of payments each month, including an interest-only option and a minimum payment option that does not cover all of the interest owing.

While these mortgage options can make it easier for some people to afford homes by providing lower monthly payments, they also carry more risk than traditional fixed-rate and adjustable-rate loans. Here’s an overview of how the proposed guidelines would address the major concerns:

  • More thorough disclosure: With a traditional mortgage, payments include both principal and interest, so the balance of the loan is reduced every month. When a homeowner pays only the interest, however, the balance is never reduced. Even more worrisome is negative amortization -- when monthly payments do not cover all the interest due, the homeowner ends up owing more than the original amount of the loan. The federal agencies want to make sure that lenders properly explain these risks, and that borrowers fully understand them before taking out a nontraditional loan.
  • Repayment adjustment: After an initial period, the low monthly payments of nontraditional mortgages generally rise substantially. Borrowers who were attracted by the low introductory rates or payments may find themselves suddenly unable to meet their new financial obligation. Lenders may be required to adjust their schedules to reduce this “payment shock.”
  • More stringent approval process: Nontraditional mortgages may be offered to borrowers who do not qualify for traditional financing because of poor credit or incomplete documentation. New rules may oblige financial institutions to be more rigorous when approving applications, and may require borrowers to submit proof of their income and their ability to carry higher debt loads.

The federal agencies’ recommendations may compel financial institutions to offer fewer nontraditional loans.

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