Federal banking regulators proposed new standards regarding Option Arm and Interest only mortgages.
The use of Interest Only mortgages has increased by 30% over the last 5 years probably due to the meteoric rise of home prices.
According to CNN, “approximately 40% of homes purchased in 2005 were financed by either option ARM’s or interest-only loans”.
With an interest only mortgage the borrower pays only the interest on the principal. For example lets take a look at a loan that I posess. It’s an interest only mortgage from Countrywide on one of my investment properties. The loan type is described as a 30 yr fixed interest only at an interest rate of 7.25%. On a loan amount of $171,000, the payment is $1033 per month. This type of mortgage is an attractive option for real estate investors because it allows them to maximize their cash flow.
With a negative amortization mortgage or option arm (adjustable rate mortgage) the borrower has several monthly payment options. One option is to pay less than the interest owed which allows them to have a lower monthly payment, but they have to pay the piper at some point. The interest that should have been paid gets added to the original loan amount. As a result, the home owner could end up owing more money on their mortgage, not less after a given period of time.
The new Federal standards may require banks to increase their capital reserves as a protection against these riskier loans. When banks have to keep more of their cash on hand, less cash is available for lending which causes banks to limit offering these products.
A tightening of lending practices means less money for buyers to borrow which could affect and already cooling real estate market.