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Mortgage Industry Changes Coming

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After years of easy mortgage loans, some lenders are starting to tighten their lending standards. This comes after Alan Greenspan, chairman of the Federal Reserve, expressed concern over the lax standards mortgage lenders are using to approve loans. Many mortgage lenders have offered new mortgage loan products over the past years that are designed to make purchasing homes more affordable and allow more people to cash out equity from their homes without increasing monthly payments. Today, in what appears to be a reversal, many mortgage lenders are raising their standards for offering these loans to consumers. Interest rates for many mortgage loans are rising as the Fed has raised short term interest rates for the 11th consecutive time. Many mortgage lenders are now making it difficult for homeowners to qualify for mortgage loans. Mortgage lenders are cutting back on the riskier mortgage loans they make or raising interest rates on these loans.

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One of the larger mortgage lenders has told brokers that it will make it more difficult to qualify for option adjustable rate mortgage loans. With the new rules, potential borrowers will have to show they can afford the payments on the loan when the interest rate goes up after the introductory rate terminates. Currently, the interest rate for qualifying for this type of loans is 5.25 percent. Many mortgage lenders are making their loans more expensive, which could discourage mortgage borrowing. The changes come as lawmakers are sounding the alarm about risks in the mortgage industry. Fed chairman Alan Greenspan stated that the dramatic rise in option and interest only loans could be dangerous for the economy. If the housing market declines, lawmakers are concerned that foreclosures could skyrocket. For homeowners, the changes in lending standards could make it more difficult to afford homes; this could cause the housing market to cool. This could take many people out of the housing market. This change in mortgage lending is not widespread yet; many mortgage brokers say they have not seen any changes at all yet.

Raising the interest rates on mortgage loans increases the monthly payment a homeowner make; especially in the mortgage’s early years. Tighter lending standards also come because profit margins for lenders are shrinking. Credit agencies are also tightening standards for mortgages. Other changes may be less prominent for homeowners; at least for the short term. Many lenders that sell option adjustable rate mortgages (ARM) are raising the margin used to set the interest rate on the mortgage once the introductory period is over. To set the interest rate on the mortgage, lenders usually add the margin and an index that measures short term rates. Because the index used goes up with market rates, the lenders wider margins will be an extra cost for borrowers on top of any increases in short term rates.
The problem with option ARM loans is that the introductory rate is very low and the monthly payment is not high enough to cover the interest due during the early years. This means that interest is added to the principal balance; this is called negative amortization. The borrower ends up with a larger mortgage loan then they started with. Homeowners could also find sharp increases in their monthly payments later on down the road when their payment is reset to a 30 year term. Before the recent lending changes, increases in short term rates have been making option ARM loans much less attractive. Along with these changes, many mortgage lenders are pushing homeowners to loans that have prepayment penalties. Lenders are doing this to discourage homeowners from refinancing mortgage loans.

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