Strategy puts US buyers at risk

PUBLISHED : Wednesday, 20 April, 2005, 12:00am
UPDATED : Wednesday, 20 April, 2005, 12:00am

Foreclosures are rising as a third of the nation's owners who took out interest-only loans feel the pinch

The buy-now-pay-later strategy of millions of American homeowners is facing mounting risks. In some parts of the United States, the number of foreclosed residential properties has soared in recent weeks.

Nationwide, they increased by 50 per cent from February to last month. Most at risk are those homeowners who purchased their property with risky financing, such as interest-only loans.

In the past three years, a rapidly increasing number of Americans has helped to fuel the ongoing real estate rally by taking up interest-only loans that offer lower monthly payments in the initial period, before the down payment sets in.

In California, where this form of creative financing is most advanced, 48 per cent of homes were bought with interest-only loans last year. That compares to a ratio of less than 2 per cent in 2001, according to San Francisco mortgage research firm LoanPerformance.

Nationwide, a third of homes were bought with interest-only financing. Economists are getting worried about the high percentage of these risky loans in the market, because they rely solely on home price appreciation to boost equity.

In areas where population and job growth have been relatively weak in recent months, sales are slowing and price appreciation is becoming stagnant.

In Ohio, which lost more jobs than any other US state since 2000, the number of foreclosures shot up by 51 per cent last month, according to a survey by the listing service

The sharpest increases come from states in the Midwest, which is beset by problems in manufacturing, partly stemming from the ailing vehicle industry.

In Michigan, the heartland of the US car sector, foreclosures rose 58 per cent, in Indiana 51 per cent and in Kentucky 44 per cent. In New York, foreclosures rose by 53 per cent.

The number of foreclosures rose in 47 states last month. president Brad Geisen said: 'If the combination of rising interest rates and dropping home values continues, foreclosure inventory will likely continue to rise across the country.'

Real estate executive Don Wick confirmed the pressure on the market in Ohio. 'All over the state, builders are cutting their margins, offering incentives and increasing their marketing.'

Mr Wick is vice-president at Rockford Homes, a home builder in Columbus, Ohio. Companies in the area have started to offer incentives such as US$5,000 worth of free upgrades to prospective buyers.

The impact of rising rates on borrowers who use interest-only loans is hard to forecast because the financing vehicle is too young.

Marco Van Akkeren, an economist at PMI Mortgage Insurance, has studied the potential impact.

His benchmark is a median-priced home in the San Francisco-Oakland-Fremont area. A borrower with 20 per cent down payment and a three-year, interest-only loan could see monthly payments on a US$646,000 home skyrocket from US$2,154 to US$3,556, if the initial rate of 5 per cent were to increase two percentage points to 7 per cent at the first adjustment period.

With many borrowers mortgaged to the limit, rising rates or a slowing economy - as forecast for the rest of the year - could put a lot of them in dire financial straits.

Meanwhile, Fitch Ratings analyst Bob Curran hesitated to ring the alarm bells. He said that foreclosed properties still represented a very small percentage of the overall housing inventory. The recent foreclosure numbers 'may simply reflect our overleveraged society and the fact that people are carrying more debt on everything and it does not take a lot to affect a small percentage of them in terms of moving them from homeownership to not', he said.

Mr Van Akkeren was not so sure about a soft landing. 'If an economic shock were to occur, the housing market is pretty vulnerable to price declines,' he said.