Luisa Cordova-Holmes was looking to lower her monthly payments when she refinanced her $312,000 mortgage in 2004. Instead, she wound up digging herself into a ditch.
For their new loan, Cordova-Holmes and her husband chose a so-called option adjustable-rate mortgage, which carried an introductory rate of 2.35 percent and gave her multiple payment choices each month. "I had a lot of financial obligations," says Cordova-Holmes, an accountant who lives near Detroit.
Two years later, however, the interest rate on her loan has jumped to 8.75 percent, her loan balance has climbed to $324,000 and her minimum monthly payment has risen to $2,257. She says the terms of the loan weren't clearly spelled out.
Cordova-Holmes says she would like to refinance, but can't -- in part because her loan carries a prepayment penalty that would force her to shell out thousands of dollars if she did. Instead, she's trying to sell her home. But with Detroit's economy slumping, she hasn't been able to find a buyer. When she and her husband first put the house on the market last summer, they were asking nearly $400,000. Now they're willing to accept as little as $270,000.
"We're in a very bad situation," she says. "The payments are just killing us."
In recent years, homeowners like Cordova-Holmes have embraced adjustable-rate mortgages -- and such variations as option ARMs, interest-only mortgages and "piggyback" loans, which, respectively, allow borrowers to make a minimum monthly payment, pay interest and no principal in the loan's early years, or finance 100 percent of the purchase price. The growing popularity of these products has helped fuel consumer spending, as well as double-digit home-price gains and rising homeownership rates.
Yet the downside of the lending boom is starting to show. Rising interest rates are taking a toll on family budgets as growth in home prices flattens -- and, in some areas, prices fall.
Mortgage delinquency rates hit 2.32 percent in the second quarter after bottoming out at 2.06 percent in the fourth quarter of 2005, according to an analysis by Equifax/Moody's Economy.com. The portion of adjustable-rate mortgages that were at least 90 days past due has climbed 141 percent in the past year, according to a recent study by Credit Suisse that looked at loans made to borrowers with good credit. That compares to a 27 percent rise in such delinquencies for fixed-rate mortgages.
Many borrowers who run into trouble have relatively low incomes or scuffed credit records. But housing counselors say they are also hearing from a growing number of middle- and upper-middle-income borrowers who borrowed heavily to finance spending or buy a house they could barely afford. NeighborWorks Homeownership Center in Sacramento, Calif., says that 38 percent of the borrowers it's seen this year have "moderate or above-moderate" incomes, up from 24 percent last year.
In Illinois, the new crop of borrowers includes people with bills for private schools, fancy cars and child care and monthly incomes of $3,500 to $10,000, says Michael van Zalingen, director of homeownership services at Neighborhood Housing Services of Chicago. Many of these borrowers took out loans that didn't require them to document their income and overstated their earnings, he adds.
Steven Schwaber, a bankruptcy attorney in the Pasadena, Calif., area, says he's getting more calls from small-business owners who had refinanced into ARMs, tapping their equity in an effort to keep their businesses afloat. "All of the sudden their budgets are out of whack because their house payment went up by 25 percent or 30 percent," he says, at the same time fuel prices are rising. Some would have wound up filing for bankruptcy anyway, he adds, but rising interest rates have pushed others over the edge.
Credit-counseling agencies say that in the past few months they've seen a growing number of homeowners pinched by rising mortgage payments. Neighborhood Housing Services of New York City says it's been "flooded" with calls from borrowers who took out ARMs two years ago and whose rates are now resetting for the first time. And Consumer Credit Counseling Services of Atlanta, which works with borrowers nationwide, says it has tripled its housing counseling staff in the past six months to keep up with increased demand.
Until recently, most mortgage-payment problems were an unfortunate byproduct of major life changes, such as job loss, medical problems, divorce or a death in the family. But for the new wave of troubled borrowers, the problems stem largely, or in part, from the structure of their mortgage, housing counselors say.
In the past, the home mortgage "was a steadying influence; it neither rose nor fell over time," says Elizabeth Warren, a Harvard Law School professor who has studied consumer bankruptcies. "All that has changed in the last half-dozen years," she adds. "The mortgage payment is now more variable than any other expense for millions of people. We're working in completely uncharted territory."
Rising mortgage rates are causing problems for first-time home buyers such as Edward Snyder, a product manager who bought his house in St. Paul, Minn., two and a half years ago. Snyder financed the $210,000 purchase with a $168,000 interest-only ARM that carried a fixed-rate of 6.15 percent for the first two years and a $42,000 second mortgage with a 9.4 percent rate that is fixed for the first three years.
Snyder says he was stretched even before a rate adjustment on his ARM boosted his monthly payments by $200 in May. Since then, he has fallen behind on his water bills, car payments and student loan. "Now, it's a choice of what gets paid late," Snyder explains. Last month, he received a letter from his lender with the words "rate increase" on the envelope. Snyder says he hasn't opened it "because it gets too discouraging." This week, he's meeting with a mortgage broker to discuss his options.
"If I had been aware both loans were interest-only, I would have probably turned the loan down," says Snyder, who says that the terms of the mortgage were never properly explained to him. "I believe this loan is built for failure. There's no means to build up equity."
Roughly $137.5 billion in residential mortgages will face payment resets this year, with an additional $524 billion resetting over the next four years, according to a recent analysis by UBS AG that looked at loans sold to investors who buy mortgage-backed securities. Rising interest rates aren't a problem for most of these borrowers because they can refinance or have the cash to meet higher mortgage payments. Borrowers with troubled credit records may be able to refinance into a mortgage with a lower rate if they've been paying their bills on time.
But other borrowers are running into trouble, in some cases because they didn't understand the risks of their mortgage or wound up at the closing table with a loan that wasn't what they expected. More than 30 percent of mortgage brokers believe their clients don't understand the mortgage product they selected, according to a recent survey by Macquarie Mortgages USA, a unit of the Macquarie Group. Other borrowers didn't leave a cash cushion to cover higher mortgage payments at a time when gasoline costs and minimum credit-card payments are also rising.
"Often the reason somebody is put into an ARM or an interest-only loan ... is because that's the only way the broker or loan officer could get them qualified," says Jordan Ash, director of the Acorn Financial Justice Center, an advocacy group that focuses on predatory lending issues. Acorn is currently negotiating with two large subprime lenders -- who deal with borrowers with blemished credit records -- about changes in underwriting standards and how to deal with borrowers whose interest rates are resetting.
Rising rates create new challenges not only for borrowers, but also for lenders that would prefer not to foreclose. When borrowers miss payments because of a sudden interruption in their income, a lender may structure a repayment plan that allows the borrower to make catch-up payments or do a loan modification that adds the unpaid debt to the loan balance. But if the problem stems from rising mortgage rates, a borrower may have to get a second job or prune spending.
Some lenders are trying to alert borrowers to a payment reset well in advance, either through their Web sites or with phone calls or letters. They are also offering refinance options, such as switching from an ARM to a fixed-rate interest-only mortgage. A switch could mean higher monthly payments, but it insulates the borrower from future rate increases, says Bill Merrill, director of nonperforming loans at mortgage giant Freddie Mac.
But for some borrowers, "there may not be a solution," says Doug Duncan, chief economist of the Mortgage Bankers Association. "ARMs always have higher delinquency and foreclosures" than fixed-rate loans, he says.
Some borrowers are opting to sell homes they can no longer afford. Last year, James Zito, a retired salesman, refinanced into an option ARM in a deal that allowed him to pull out $50,000 in cash without increasing his monthly payments. Zito had been pulling out cash when he refinanced every three or four years. But this time, when his mortgage payments began adjusting, he realized he couldn't afford the higher payment, and refinancing yet again wasn't an option.
In June, Zito sold for $745,000 the three-bedroom, two-bath house in San Jose, Calif., he had lived in for 43 years and bought a smaller home in a retirement community. "I wanted to get out from under the mortgage," he explains. With an option ARM, "your monthly payment increases, and you don't make any headway."
Some California brokers say they are beginning to see a return of "short sales" -- transactions in which the sales price isn't large enough to cover outstanding loans. Patti Vaughan, an agent with Assist 2 Sell in Temecula, Calif., says in recent months she has begun to get calls from borrowers looking to unload houses they can no longer afford. "They've upgraded their houses, put in a pool and bought themselves Hummers and BMWs," she says. "Now they can't get it refinanced and they can't sell."