Real Estate Update in Palo Alto & Los Altos

Forget buyer’s market and seller’s market: housing today is a banker’s market. And borrowers are feeling the pain.

The one-two punch of a tighter mortgage environment and tougher credit standards is forcing buyers toward more conservative home loans, according to economists who study the mortgage industry.

Home buyers and homeowners who want to refinance are moving away from shorter-term adjustable rate loans, according to the Mortgage Bankers Association.

Shorter-term adjustable-rate mortgages (anything that reverts to an adjustable rate in less than four years), which two years ago accounted for more than one out of every three closings, are dropping in popularity. “Piggyback mortgages” (used to finance all or part of a down payment) are getting pricey, pushing buyers to pony up cash for down payments instead, says Jay Brinkmann, vice president of research and economics for the association.

So where does that leave the borrower who needs a more nontraditional loan? “Even if customers want it, they may not be able to find it,” says Brinkmann.

2 kinds of buyers
“Borrowers tend to fall into two camps,” says Brinkmann. Conservative buyers “are willing to pay more now for not having the risk of payments going up later.” The rest focus almost solely on the monthly payments, asking “what is the smallest payment that will get me into a house,” he says.

Both groups are shying away from short-term adjustable loans, he says.

For conservative borrowers, the chance that the payment could increase beyond their comfort level is a very real and unwelcome possibility. They prefer the certainty of a fixed-rate 15- or 30-year mortgage, Brinkmann says.

Check the odds
What are the odds you’ll go into foreclosure? While everyone’s money situation is different, lenders also look at the odds associated with each type of loan. Check out your loan type for the current odds.

For buyers intent on getting the smallest possible monthly payment, adjustable rates are no longer automatically the ideal. Payments can go up and the ability to refinance in a few years is not a sure thing.

Homeowners who put down 2 percent to 5 percent a few years ago “are finding they can’t qualify for refinancing because they don’t have enough equity,” says Brinkmann.

Subprime borrowers looking for the smallest monthly payment are discovering that a fixed-rate loan may offer them a better payment plan, especially if they won’t be able to refinance.

By the spring of this year, the percentage of buyers taking out shorter-term adjustable-rate mortgages had dropped from 36 percent to 17 percent, according to the association. As home-buying season got into full swing in late spring and summer, the popularity of the loans increased slightly. Currently, about one in five home buyers signs on for a shorter-term adjustable-rate loan.

“The market is tightening up, and at the same time, borrowers are much more cognizant that these teaser-rate mortgages are not a free lunch,” says Lawrence Yun, senior economist with the National Association of Realtors.

But Yun disputes any suggestion that buyers are making larger down payments. Recent data suggests that while median home prices have dropped roughly 1 percent in the past year, today’s borrowers are bringing slightly less cash to the closing table, he says.

Last year, a home buyer typically put almost 24 percent down, says Yun, citing data from the Federal Housing Finance Board. This year, the average down payment is closer to 20 percent. “People are taking out a little larger loan,” Yun says.

At the same time, “there is a downward trend in adjustable-rate mortgages,” says Yun. “So in a sense, borrowers are being more cautious of these types of mortgages.”

With several lender bankruptcies coupled with tighter lending standards in the subprime market, “even if people wanted to take riskier subprime loans, they would have difficulty,” he says. “Funding is just not there.”

As a result, many low- to moderate-income households “will be moving into FHA government-backed mortgage products, which had traditionally been the choice of low- to moderate-income households,” he says.

Yun also predicts that buyers soon will be making larger down payments.

Recently, there have been “so many disruptions in the mortgage market, I do anticipate that down payments will be increasing,” he says.

Interest-only loans remain popular

One nontraditional mortgage that’s still flourishing: the interest-only loan. Almost 29 percent of mortgages in the second half of 2006 were interest-only loans, up 3 percent from the first half of the year, according to mortgage association data.

Interest-only loans are sometimes tagged “exotic” because they focus on paying the mortgage interest (rather than interest plus principal) for at least a period of time — allowing borrowers to sign on for more house with smaller monthly payments. Proponents see them as a tool that allows buyers who will soon be earning a much larger paycheck to secure that more expensive home.

The loans haven’t received the negative attention that has plagued the subprime lending market recently, so the supply is still plentiful, says Brinkmann. That could change as regulators begin to take a harder look at these mortgages in the future, he says.

But interest-only loans are not just for people banking on bigger future paychecks. They also offer some flexibility that can be very practical in certain circumstances.

Dr. Jud Schoendorf never thought he’d opt for anything but a traditional, fixed-rate loan. But when he bought his 2,000-square-foot Long Beach, Calif., home in November, he was in a difficult financial situation. He was closing on the new home before selling the old one and would be carrying two mortgages in the interim. While he wanted to put a large chunk of his home profits toward the principal of the new home, he wouldn’t receive that cash until after he’d taken out his new mortgage.

An interest-only loan would let him pay down the principal after closing and reduce his monthly mortgage payment. A fixed-rate loan wouldn’t give him any flexibility in that area.

He selected a mortgage that converts to an adjustable rate after five years. But for him, the idea of an interest-only loan was a big departure from the norm. “I didn’t like it,” Schoendorf says of paying just interest and not the principal, too. “There’s something more satisfying about being able to pay both.”

With great credit and a large amount of equity in the new house, he’s just waiting for the rates to drop below 6 percent to refinance at a fixed rate.

Based on the numbers, Schoendorf says, “It was well worth taking a chance that in the next four years the rates will come down.”