Rising mortgage rates may spur riskier loans

updated 4:53 p.m. ET Nov. 3, 2005

ORLANDO, Fla. - Low interest rates have ensured that mortgage bankers had to do relatively little to attract new business in recent years. But this likely will change as borrowing costs rise and bankers now worry some lenders will make risky loans to keep their businesses alive.

Mortgage bankers processed close to $4 trillion of mortgages in 2003, a banner year. While business in the last two years has been exceptional — twice the annual average in the 1990s — it is expected to fall off some 18 percent in 2006 from 2005’s projected $2.78 trillion, according to the Mortgage Bankers Association (MBA), an industry trade group.

Much of that drop is expected because higher rates make home purchases more expensive and fewer home owners will have the incentive to refinance their home loans.

Rates for 30-year mortgages had been below 6 percent for much of this year, encouraging home buying and price appreciation. But these rates are half a percentage point higher than a year ago and they are expected to continue their climb. By next fall rates for 30-year mortgages, now at around 6.21 percent, are seen hitting 6.65 percent, according to the MBA.

According to the MBA, 15 percent of American homeowners have adjustable rate mortgages, loans which reset once a year and are correlated to short-term interest rates such as Treasury bills. So a homeowner who borrowed $100,000 3 years ago at a rate of 4 percent now pays 7 percent interest, thanks to recent interest rate hikes like the one announced by the Federal Reserve Board Tuesday. That means payments initially set at $477 a month are now $650 and could rise again if there are future rate hikes.

The industry trade group estimated each quarter point increase in short-term interest rates means consumers with ARMs spent about $500 million more a month on loan payments.

The rise in borrowing costs comes at a time when home buyers are spending more of their income to buy a bit of the American dream.

According to data compiled by the National Association of Realtors, home buyers were spending close to 21 cents out of every dollar earned on monthly mortgage payments during the second quarter of 2005, up from previous years when mortgage rates were lower. The group’s housing affordability index — a measure of consumers’ ability to make monthly mortgage payments started in 1970 — was at a low during the second quarter of 2005 not seen since 1991.

Ray Morris, director of business development at GMAC Mortgage Corp. predicted that more banks will lend to risky borrowers, or what is known as the sub-prime market, to keep their businesses going.

“Will there be some (risky lending)? I am sure there will be,” said Regina Lowrie, president and founder of Horsham Pennsylvania-based Gateway Funding said. But she said this would be the exception and not the rule.

Lowrie said bad loans could be costly to her firm so she has increased scrutiny of loan terms, property values and credit histories of borrowers.

Some of that aggressive lending to less creditworthy borrowers, though, may already going on.

“People are getting in trouble by buying out of their price range. They are dreaming really big,” said Tina Smith, an executive with String Information Services, a company that provides back-office support to mortgage banks. “That could be a disaster later,” she said.

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