Who is Most at Risk in the Slowing Market? By Martin Lukac

The slowing housing market and increased interest rates have led to many experts forecasting foreclosures and bank losses on risky mortgages.

While the market hasn't completely fallen in on itself, delinquency rates are on the rise in many areas across the country. Many homeowners who purchased homes using nontraditional mortgages, such as option ARMs and interest only, are beginning to worry about the rising rates and declining home values.

Regulators are calling for lenders to cut back on the number of exotic and nontraditional mortgages they are granting, but many aren't becoming any stricter with their approval standards.

"Mortgage lending standards show little sign of tightening," says Frederick Cannon, bank analyst with New York's Keefe Bruyette & Woods Inc. investment bank. "Lenders should have dialed back the aggressive loans by now."

Lenders say that the competition between mortgage companies and banks remains strong, leaving them no choice but to compete using the most popular forms of mortgages. Former Federal Reserve Chairman Alan Greenspan admonished lenders last year for enticing borrowers to take on more debt, with little or no documentation, offer low minimum payments, offer high-percentage mortgages and permit borrowers to carry more than the traditional amount of debt.

"Both the banks and consumers are stretching," says Peter J. Winter, an analyst with Harris Nesbitt Corp.

Borrowers, it seems, aren't the only ones risking losses.

Delinquency rates jumped more than 7% in the forth quarter of 2005 to 4.7%, according to the Mortgage Bankers Association.

Home owners are finding themselves in financial troubles due to debt and cost of living increases. For example, in California, one in five buyers already spends more than half of pretax household income on housing. The recommended housing allotment is 30% by HUD, most strict lenders consider 28% the top end.

The focus of many critics is on subprime lenders, who make loans to borrowers with poor credit. Subprime lenders issued $650 billion in mortgages last year.

Many subprime lenders offload their risk by selling the loans to Wall Street for repackaging for investors. They argue that this moves the risk from their balance sheets to the broader market to absorb.

Many borrowers are on the edge of a payment shock this year. Repayment terms on over $1 trillion in adjustable rate mortgages will increase in 2006 and 2007 due to interest rate adjustments. Some borrowers are facing increases of 150% in their monthly payments.

"In the hands of an unsophisticated borrower, they are dangerous," says Robert W. Visini of LoanPerformance of the risks with nontraditional loans and some ARMs.

According to research by CIBC World Markets Inc., almost 10% of households face a great risk of credit problems. When borrowers begin to default on their loans, it costs the lenders as well. The risk will potentially be to all, not just the borrower. And when the lender has more costs, the future borrower has more costs.