The GSEs no longer buy or insure interest-only loans; the last vestige of Ponzi financing washes away.
Hooked into this deceiver
Need more and more
Into the endless fever
Need more and more
New consequence machine
Burn through all your gasoline
Asylum overtime
Never mind
You reach the end of the line
Metallica — The End Of The Line
Interest-only loans have reached the end of the line. I discussed interest-only adjustable rate mortgages in Conservative House Financing – Part 1:
The advantage of IO ARMs is their lower payments. Or put another way, the same payment can finance a larger loan. This is how IO ARMs were used to drive up prices once the limit of conventional loans was reached (somewhere in 2003 in California). A bubble similar to the last bubble would have reached its zenith in 2003/2004 if IO ARMs had not entered the market and inflated prices further. In any bubble, the system is pushed to its breaking point, and it either implodes, or some new stimulus pushes it higher: the negative amortization mortgage (Option ARM).
Besides the low interest rates, the continued use of these products has helped support our market at 2003/2004 prices despite the still inflated price levels. Will removing this form of financing cause prices to fall?
(Federal Citizen Information Publication link)
Freddie Mac Will Cease Purchases of Interest Only Mortgages
McLean, VA – Freddie Mac (NYSE: FRE) announced today that on or about September 1, 2010, the company will cease purchasing and securitizing interest only mortgages, including Freddie Mac Initial InterestSM fixed-rate and adjustable-rate mortgages.
Freddie ends buying of all interest-only mortgages
By Lynn Adler
NEW YORK, Feb 26 (Reuters) – Freddie Mac (FRE.N), the second largest purchaser of U.S. residential mortgages, said on Friday that it would stop buying and securitizing all interest-only mortgages because of the poor performance of those loans.
Interest-only mortgages, or IOs, including Freddie Mac’s Initial Interest mortgages, provide only interest payments for a specified period starting with the first monthly payment, and then principal and interest for the rest of the loan term.
In its fourth quarter results this week, Freddie Mac said the unpaid principal balance of IO loans was almost $130 billion at the end of December, or 7 percent of its total portfolio.
Nearly 18 percent of those loans were seriously delinquent, meaning at least 90 days late.
“This change is another step in our efforts to refine our mortgage credit and purchase requirements to promote responsible lending and sustainable homeownership,” Freddie Mac spokesman Michael Cosgrove said.
About 14 percent of the loans had credit enhancements, according to the company. The average unpaid principal balance per loan was $254,601, Freddie Mac said.
“Our decision to stop purchasing all interest-only type mortgages — through all flow and bulk purchase paths — and to retire our Initial Interest fixed-rate and adjustable-rate mortgage products in the coming months is a result of continuing poor performance of these products in aggregate,” Cosgrove said.
Freddie Mac said it would end its IO purchase and securitization activity on or about Sept. 1.
When you cut through the BS, Freddie Mac bailed on interest-only mortgages because they are losing too much money — we were losing too much money. As the guarantor, taxpayers should be happy this program is being eliminated.
The impact this will have on the housing market is yet to be seen, but eliminating affordability products, by definition, harms affordability. In a rising market, this is a speedbump, but in a weak market, it is another reason for continued price weakness. Many marginal buyers who would have used this unstable financing option must now reduce their bids.
Freddie Mac: Final Nail in the Coffin of Interest Only Mortgages?
For those unfamiliar with interest only loans, in general it is a mortgage that the borrower agrees to only pay the interest on the debt for a set period of normally five or ten years. At the end of the interest-only period, the mortgage payment “balloons” because the borrower must begin paying off the principal as well as interest. Many times, the purpose for such a loan is for a person who wants to buy a house and believes their future income will increase to cover the payments that otherwise they would not be able to afford. It is easy to understand why these loans get a lot of the blame for inflating the housing bubble. Obviously, the problem arises when the borrower’s income does not meet their expectations, or as is all too common these days it disappears entirely. Furthermore, this type of loan can be particularly destructive when the housing market falls because there has been no dent made in the principal amount, so a home owner can be “underwater” more quickly.
…. Underwriting standards have necessarily become stricter since the housing bubble burst, and borrowers are often required to have substantial down payments. However, if the GSE’s are no longer willing to buy up these IO mortgages on the secondary market, there are certainly few banks willing to take the risk on getting stuck with more non-performing loans. This is not to say that the IO loan is dead and gone forever, but at least for now Freddie Mac is doing its part in killing this relic of a bygone era.
Good riddance. Interest-only financing is the Ponzi limit. Once this threshold is reached, there is no turning back. Option ARMs crossed this limit, and they disappeared about 2 years ago,and now financing at the Ponzi limit is dead as well. If you want a sign we are ready to inflate the next housing bubble, wait for this form of financing to reappear. Perching on the cliff is the last stop before the abyss.
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