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Banks And The Mortgage Frenzy Staff - Mortgage Lenders Plus.com

Now that the feeding frenzy in the housing market seems to have abated, the financial institutions that made it all possible are looking around and wondering what they hath wrought. Interest only home loans made it possible for millions of home buyers to purchase houses that, absent a rise in household income, they could not afford to buy.

With the proliferation of increasingly risky mortgages, you'd think that banks would do more to protect themselves against a tide of bad loans. What appears to have occurred, however, is that the financial institutions bought into the notion of a never-ending spiral in housing values that would make it all work. Not only were they handing out 100% financing on houses, home owners that had a few year’s residence under their belt could obtain interest only home equity loans as well.

By the first half of 2006, thirty seven percent of all home loans adjustable rate mortgages and the huge majority of those were interest only home loans. With these mortgages, the monthly payments rise spectacularly when they adjust to market rates, usually after a period of five years. Many people used them to borrow to the max, because they could afford the initial monthly payments.

The assumption was that they would be able to refinance out of an interest only home loan after five years because of home appreciation. That may well not materialize, and this will surprise many borrowers. When their payments further soar, because of rising interest rates which most economists predict many borrowers will go into shock.

The same applies to interest only home equity loans. A major home refinance that takes all the accumulated equity out in cash leaves a home that is 100% financed. People who run into financial problems in a situation like that are not going to have another refinancing option, and many of them will be forced to walk.

All of this has led the mortgage reinsurers to ask for federal controls on interest only home loans and other exotic financial devices such as option ARMs. People in the industry are getting nervous and analysts are recognizing that, as regards home mortgages and household debt in general, we are in uncharted waters.

Bankers will argue that such devices as interest only home loans were designed for sophisticated borrowers who understood the implications of the loan and had both the plan and the wherewithal for refinancing under any circumstances. If that was the case, it surely did not slow down mortgage companies. An enormous percentage of interest only home loans went to subprime borrowers.

In similar fashion, many interest only home equity loans were issued to people who needed them because of credit problems elsewhere. With banks' loan-loss-reserve ratios now less than half of what they were in 1991, these institutions are not at all prepared for the situation they have created.

All of the statistics that the financial institutions have used as benchmarks are out of whack. The loan-to-value (LTV) on the average home is way off the traditional ratio. The limit for monthly household gross to be put toward housing costs used to be 38%. That guideline is out the window, as many young homebuyers are spending over half their gross on house payments. The use of interest only home loans may haunt many banks, as foreclosures continue to rise.