The Feds Miss An Opportunity to Explain Teaser Ratesby
Teaser rates on exotic mortgages have gotten lots of borrowers into deep financial trouble. Fooled by the low initial rate, homebuyers took on more debt than they could afford, as they’re now beginning to realize as rates reset upward and they can’t refinance.
Federal regulators have missed a great opportunity to educate the next generation of borrowers to prevent more teaser disasters. Yesterday, regulators put out three pieces of literature that are supposed to warn people of the risks of what are euphemistically called “nontraditional mortgage products.” The bureaucratic document, for those who want the gory details, is here.
I see two big problems with what the feds did:
1) They made it voluntary, rather than mandatory, for lenders to use the literature in counseling consumers about loan suitability.
2) Two of the three pieces of literature offered by regulators are so weak that in my opinion they wouldn’t do anything to dissuade a naive borrower from grabbing an attractively low teaser rate.
The only one I like …
... which is called Illustration No. 2, is a table that compares three 30-year mortgage loans of $200,000 each based on a 7% rate: a conventional fixed loan; an interest-only mortgage; and a payment-option ARM.
The fixed loan in the example has a starting payment of $1,331. In year six, if rates don't change, your payment is still $1,331. After five years, your loan payments have given you $11,737 in equity.
The interest-only ARM has a starting payment of $1,167. In year six, if rates don't change, your payment is $1,414. After five years, your loan payments have given you $0 in equity.
The payment option ARM has a starting payment of $739. (Nice!!!!) In year six, if rates don't change, your payment is $1,565. (Not so nice.) After five years, your loan payments have given you a negative $21,486 in equity, meaning that you owe more than when you started. (Ouch!!!!)
If every borrower who was considering a payment option ARM during the boom years had seen something like that illustration before signing, a lot of them would have backed off and saved themselves years of distress and heartache.
The other two illustrations are worse. Illustration No. 1 doesn't include any examples so it comes across as just a lot of ignorable boilerplate. Illustration No. 3 is bewildering. It seems to be aimed at people who already have payment option ARMs and are trying to decide how much of a payment to make each month. Naturally the minimum payment looks the most attractive, although there's text explaining that it may cause your loan balance to go up.
But since none of the illustrations is required anyway, it doesn't really matter which one best conveys the dangers, does it?