The Star-Ledger, October 18th, 2006

The Star-Ledger Archive COPYRIGHT © The Star-Ledger 2006

Date: 2006/10/18 Wednesday Page: 055 Section: BUSINESS Edition: FINAL Size: 1330 words

Homeowners enticed by the promise of low-cost mortgages may find themselves sinking under the debt


For thousands of cash-strapped homeowners like Leah Belverio, the clock is ticking.

The 34-year-old hairdresser purchased a $190,000 home in Belleville 18 months ago along with her boyfriend. When the couple split up, Belverio, determined to hold on to her home, became a serial refinancer.

She dropped a 6.5 percent fixed-rate mortgage in favor of a ridiculously cheap adjustable-rate loan with a low monthly payment.

To pay her bills, she cashed out nearly every dollar of equity in her home. To wipe out nearly $50,000 in credit card debt, she was told, she could take out a new, bigger mortgage.

Today, her initial $185,000 mortgage has ballooned to $247,000 -- perhaps more than her home would fetch on the open market. And her monthly payment has skyrocketed from $1,375 to almost $2,000 -- and might go up even further in two years when her 10 percent "teaser rate" adjusts higher.

"I'm trying to keep my head above water with everything, my mortgage and bills," Belverio said. "I'm the type of person, I don't look that far into the future."

While she's managed to stay afloat so far, experts say Belverio is a prime candidate for defaulting on her mortgage, or even worse, foreclosure. And she's not alone.

Today, nearly 25 percent of mortgages carry adjustable interest rates. And most of them are held by people with poor credit, according to the Mortgage Bankers Association.

All those Cinderella loans that enticed bleary-eyed homebuyers with the promise of low monthly payments during the housing boom are starting to turn into pumpkins. Financial experts now fear the same loans that helped many homebuyers realize the American dream of owning a home are going to land some of them on the street.

To date, defaults and foreclosures on adjustable-rate mortgages remain relatively low. But experts are concerned about what might happen if the economy slows, interest rates rise further or housing prices stagnate even more.

"The jury is still out on how well these products will hold up," said Guy Cecala, managing editor of Inside B&C Lending, a leading trade publication.

Although adjustable-rate mortgages typically offer borrowers lower rates than 30-year fixed loans, the gap has been narrowing since the Federal Reserve embarked on a series of rate hikes starting in June 2004. Last month, the Mortgage Bankers Association said the gap between the average interest rate on a 30-year fixed loan (6.18 percent) and an ARM with a one-year fixed rate (5.9 percent) was the narrowest it has been since January 2001.

RISING RATES That's because while short-term rates have risen 17 times over the past two years, fears of an economic slowdown have driven down long-term rates used to set 30-year fixed rates.

As more homeowners struggle with rising mortgage payments, lenders that cater to borrowers with weak credit have reported a rise in delinquencies and foreclosures.

First American LoanPerformance, a mortgage data company based in San Francisco, said as of July 2006, the number of subprime mortgages with at least one missed payment in the first three months after origination climbed 20 percent over the past 12 months. In New Jersey, the increase was 19 percent.

And as of July, the national foreclosure rate climbed 27 percent from a year ago - nearly 35 percent in New Jersey, according to First American.

What worries experts like Christopher Cagan of First American Real Estate Solutions, a California-based mortgage research firm, are all the adjustable-rate loans made in 2004 and 2005, at the tail end of the housing boom.

'PAYMENT SHOCK' Cagan studied the loan-equity ratio for 26 million residential mortgages (or about 60 percent of the homes in the United States) and isolated those with the greatest risk of being forced into default due to "payment shock." According to Cagan's study, 29 percent of borrowers who took out mortgages in 2005 have no equity in their homes or owe more than their homes are worth.

Cagan estimates that, nationwide, $368 billion in adjustable-rate mortgages that were originated in 2004 and 2005 are sensitive to interest-rate adjustments that would lead to default, and $110 billion are expected to go into foreclosure.

He expects the number of borrowers in trouble will rise this year and peak in 2007 and 2008, as the largest number of mortgages reset to higher rates.

"This will fall on a slice of people and a slice of lenders and investors, and that slice of people will get stung badly," Cagan said. "The rest will escape. So the pain will not be equally spread."

To understand the risk level facing this "slice" of homeowners, consider the case of a typical borrower with an annual income of $30,354 who takes out a "2/28" ARM for $180,000, said Michael Calhoun, president the Center for Responsible Lending, a Washington, D.C.-based advocacy group.

'TEASER' RATES Through the second quarter of 2006, 80 percent of subprime loans were adjustable-rate loans, predominately of the 2/28 variety, he said. Those include an initial fixed rate for two years followed by rate adjustments, generally in six-month increments, for the reminder of the loan's life.

The "teaser" interest rate for the typical borrower is 7.55 percent, which results in an initial monthly payment of just $1,265. But the fully indexed rate climbs to 13.25 percent, with a corresponding monthly payment of $1,990.

"Even more disturbing," Calhoun said, "the homeowner was placed in the loan with a debt-to-income ratio of 61 percent."

The debt-to-income ratio is a simple way of showing lenders what percentage of a borrower's income is available for a mortgage payment after all other obligations are met. In a conventional loan, the maximum percentage of monthly gross income a lender typically allows for housing expenses plus recurring debt (credit card payments, child support, car loans) is around 36 percent.

At the fully indexed rate, the borrower with the 2/28 loan will have a debt-to-income ratio that rises to 96 percent.

"Put another way, this mortgage payment would leave the borrower with $125 per month to pay for food, utilities, transportation and all other essential expenses," Calhoun said.

FALSE PROMISES? A common sales pitch for 2/28 loans is that borrowers like Belvario can use those first two years - before the interest rate skyrockets - to improve their credit scores and ultimately qualify for a cheaper, more stable loan.

"I think (Belvario) knows now the equity is pretty much dried up," said Sam Ventola of Cranford-based First United Mortgage, who refinanced both her loans. "What you hope for, in her case, is this gets her back on her feet where she saves the money and her credit scores go back up."

Oftentimes, however, borrowers end up digging themselves a deeper hole.

Both times Belvario refinanced her home, for example, she sucked more equity out and racked up tens of thousands of dollars in credit-card debt, hurting her chances of qualifying for a better loan down the road.

Debt counselors say they have seen a rise in the number of people seeking help as mortgage payments skyrocket, and they expect the crowds to keep growing as many of the ARMs taken out in 2004 and 2005 start resetting at much higher payment schedules.

"We're seeing more people who are in trouble coming in," said Phyllis Salowe-Kaye, president of New Jersey Citizen Action, which operates a loan counseling service. "The bad thing is when they come to us and they are so in debt and their income-debt ratios are so high and their credit cards are all maxed out and we can't help them. But we are also seeing a lot of educated buyers coming to us who see their payments inching up and see they are heading for trouble."