Lenders wary of losses tighten mortgage criteria

By Mark Schwanhausser - Mercury News

WORRY ABOUT LOSSES FROM RISKY LOANS GROWING

Lenders are growing wary of the riskier yet more flexible mortgages favored in Silicon Valley, even as rising interest rates are making it tougher for buyers to afford the region's high-priced homes.

Make no mistake about it: As the spring home-buying season begins, the mortgage industry remains robust. Lenders are expected to churn out $2.2 trillion in mortgages nationwide this year. And they still offer a broad menu of loans designed to insulate borrowers against rising rates and squeeze payments within cramped budgets.

Behind the scenes, however, lenders, regulators and investors are making changes that could make it harder for borrowers to stretch into homes or refinance existing mortgages.

The changes could act as a gentle but largely invisible brake on real estate sales just as the home-buying season historically hits top speed, experts say.

"It's still not a bad time to be getting a loan,'' said Mark Milner, chief risk officer for PMI Mortgage Insurance in Walnut Creek. "But given the potential for rising interest rates and a slowdown in appreciation, this is probably not a good time for people to be stretching.''

There are few places where the changes will be felt as deeply as in Santa Clara County, where the median price of a single-family home topped $700,000 in January. In the San Jose area, half the home purchases relied on loans that require borrowers to pay just the interest, according to LoanPerformance, a San Francisco company that tracks mortgage data.

During the real estate boom, many Bay Area borrowers moved away from the traditional fixed-rate mortgage that charges the same monthly payment for the life of the loan. Instead, they've embraced a slew of exotic loans that require little or no down payment, delay paying down the principal or charge temporary ``teaser'' rates.

While such loans have lubricated the Bay Area's high-revving real estate market, there are growing concerns that lenders are more vulnerable to losses if buyers can't pay. And now that home prices in some areas are flattening and interest rates are flirting with three-year highs, there are mounting signs the loan industry is becoming more cautious.

In December, federal banking regulators proposed guidelines to rein in lenders peddling loans that offer below-market introductory teaser rates, interest-only loans and payment-option loans that permit payments that don't cover even the interest.

Tightened criteria
Just days before those long-anticipated guidelines were released, Washington Mutual, the nation's third-largest lender, acknowledged it had tightened its underwriting criteria on payment-option loans. It's now analyzing the borrowers' ability to pay after the introductory starting rate expires.

Industry experts are beginning to see additional changes that could affect borrowers who want to buy homes or refinance. Some lenders are less willing to let customers take out loans bigger than their incomes typically would justify. Some are shaving their predictions of how quickly rising home prices will provide equity that can cushion homeowners and lenders alike. There's more wariness of stated-income loans -- also known as ``liars' loans'' -- that don't require self-employed or borrowers with lower credit scores to document their income.

Also falling out of favor are so-called piggyback loans that add a second loan for buyers who need to borrow the down payment, said Anthony Hsieh, president of LendingTree.com, an online company that refers borrowers to lenders. Some lenders now require borrowers to pay off or refinance the balance of the second loan within two years.

Meanwhile, Wall Street agencies that grade the risk of mortgages sold to investors have made it more expensive for lenders to sell bundles of exotic loans to investors. Some smaller sub-prime lenders, who cater to borrowers with sketchier finances, are charging higher interest rates to compensate, said Grant Bailey, a director for Fitch Ratings, a bond-rating agency.

It's all adding to the anxiety of an already nerve-racking process for consumers.

Radio ads increasingly are playing off the fear of rising rates rather than the temptation of low monthly payments with an interest-only loan, said Robert Kleinhenz, deputy chief economist for the California Association of Realtors.

Panicked, ready to refi
Wells Fargo says it's getting a stream of calls from skittish homeowners holding these unconventional mortgages who want to refinance before their monthly payments vault.

And then there are home buyers who feel buffeted by rising interest rates and the risks of exotic loans. Twenty-four-year-old Catherine Gutierrez is two weeks from closing a deal for a new $305,000 condominium at the Brickyard that's just a three-minute drive from her job at Studio S(s2) Architecture in downtown San Jose. It boasts granite countertops, stainless steel fixtures and cherry-stained cabinets. She already has picked out a deep purple hue called "Sweet Truffle'' to paint the kitchen, living room and her bedroom.

"It looks sleek, it looks clean, and it's so what I am,'' Gutierrez said.

Uneasy about terms
But Gutierrez was uncomfortable when one mortgage broker first steered her toward piggyback loans, then recommended a payment-option plan that would cause her loan to grow whenever she elected to pay only a portion of the monthly interest.

"He was saying the property will appreciate more than what would be added on top'' of the original principal, Gutierrez said. ``I just didn't want to take that risk and put that much faith in the market.''

Instead, Gutierrez plans to get financial help from a parent and take out an 80 percent interest-only loan that would guarantee her five years of payments at a fixed rate.

Is she confident she can still make the payments or refinance when the payments jump in five years?

"I think so,'' Gutierrez said. ``After that I would see what rates are doing. You can't predict the future. You either jump or you don't. I'm jumping