Sunday, July 23, 2006

It is the latest twist in the gravity-defying world of the high housing prices and exotic low-rate mortgages: As monthly payments on adjustable-rate mortgages are starting to balloon, many Americans have found a way to put off the day of reckoning.

They are refinancing with new adjustable-rate mortgages that keep monthly payments low - for now, that is, though their payments will likely rise even higher in the future.

"Some people would say I am a little crazy," acknowledged R. Lance Perry, 42, of Danville, Calif., one of the new breed of people refinancing their mortgages. But faced with a sharp increase in his monthly payments and a need to take cash out of his home, he refinanced earlier this year to keep his payments the same.

By the time the rate goes up, he figures, his income will have increased enough to cover the higher payments, he will have refinanced again or he will have moved.

Like Perry, millions of Americans have turned to adjustable-rate mortgages, or ARMs, in recent years to afford a home as prices soared. Typically set at artificially low rates in the first years of the loan, these mortgages are then reset at the prevailing interest rates. For borrowers, the bet was that interest rates would remain low.

Now, the first big wave of the mortgage boom is cresting as more than $400 billion worth of adjustable-rate mortgages, or about 5 percent of all outstanding mortgage debt, will readjust this year for the first time, according to Loan Performance, a research firm. Next year, another $1 trillion in loans will readjust.

Yet instead of paying more now, many borrowers are refinancing into their second or third adjustable-rate mortgage, loan data indicate and industry experts confirm.
So far, the number of borrowers refinancing this way is relatively small - several hundred thousand in the estimate of the credit ratings firm Fitch Ratings - but mortgage industry officials and analysts expect the numbers will surge next year. In doing so, these borrowers are pushing out any eventual shock of higher payments by another two or three years, if not longer.
"They get another two- or three-year hybrid with a low introductory rate to keep payments down," said Frank E. Nothaft, a vice president and chief economist at Freddie Mac, the mortgage buyer. "They're trying to put it off forever, which is OK as long as interest rates are low. But when they start to spike, then it's going to be more problematic."

For now, this mini-refinancing boom is assuaging fears that rising interest rates and higher monthly payments would drive some borrowers into foreclosure or force them to scale back sharply on other spending. As a result, consumer spending may hold up better than some economists had thought.

But the refinancing also represents a doubling-down on a bet that housing prices will continue to rise on the West and East coasts and in other hot markets. If the value of the home falls closer to the amount of the loan, that could curb the ability to refinance, and may prompt the homeowner to either invest more in the home or to sell it.
Still, borrowers like Perry say the loans make sense because in a few years they plan to move to another home, earn more or refinance again, often using the same assumptions they made when they took out their earlier loans.

With his new loan, his third adjustable-rate mortgage, Perry, a former technology project manager, cashed about $200,000 out of his home's equity and is investing it in his four-year-old financial planning business. "I could have sold my house and made my family move," said Perry, 42, who lives with his wife and a 3-year-old son about 20 miles east of Oakland. "But I didn't do that. I said, `Look, I want to start a new business,' and this product allowed me to do that."

He said he was taking on more risk than many of his clients would be willing to, because he believes his business will continue to grow. After spending 15 years in the technology industry, which put him on the road constantly, Perry said that being self-employed allowed him to spend more time with his family, which he also expects to grow. As far as the house, he said: "I am not going to be here for 30 years. Why is it important to have a fixed mortgage?"
That sentiment resonates nationally, and especially in California.

Even as mortgage applications overall are falling because of slowing home sales and rising rates, adjustable-rate mortgages made up about 30 percent of all loans in May, down only slightly from 34.2 percent in May 2005, according to the Mortgage Bankers Association of America.
In the San Francisco Bay area, adjustable mortgages of the kind Perry borrowed make up 49 percent of all refinance loans so far this year, according to Loan Performance.

Though they have been around for decades, the use of adjustable-rate mortgages has soared in the last several years, helping fuel the housing boom by letting people borrow more than they might have been able to.

For buyers who do not intend to stay in their homes for long, they can cost a lot less than 30-year, fixed-rate mortgages.

Adjustable loans come in many forms. Most have low and fixed teaser rates initially. Many, like interest-only or "option" ARMs, also let borrowers pay only the interest portion of the debt or even less than that.

After the introductory period ends, lenders require bigger payments and ratchet up interest rates.