IN MID-2004, more and more clients began walking into First Maryland Mortgage Financial Services in Columbia and requesting adjustable, interest-only loans.
They were borrowing hundreds of thousands of dollars in many cases, thanks to Maryland's soaring home prices, but they wanted to postpone the consequences of their indebtedness as long as possible.
They didn't want to pay a full, market-based rate of interest, not right away. And they didn't want to take even teensy steps toward repaying the principal, which was once the goal of sober borrowers who toiled for decades to throw "mortgage burning" parties.
"I'm not a big fan of interest-only programs," says First Maryland President Isaiah McKenzie, but he's issuing millions in interest-only mortgages anyway, maybe 30 or 40 percent of his business this year, he says.
Why? "The customers are demanding it," he says. "We do them because the market is driving them. That's what the competition is doing."
A new report by LoanPerformance, a California finance-research outfit, says Maryland ranked No. 7 among states in the percentage of interest-only mortgages issued in the first quarter.
With 24 percent of Maryland mortgages starting as interest-only, says LoanPerformance spokesman John Lewis, this state has emerged as an overachiever in a category that many believe signals a too-hot housing market and trouble down the road.
Interest-only mortgages don't build equity. They don't force homeowners to save. And when they're the only way you can qualify for a loan, sometimes they signal that you can't afford the house you're trying to buy.
"The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other relatively exotic forms of adjustable-rate mortgages, are developments of particular concern," Federal Reserve Chairman Alan Greenspan told Congress last week.
"To the extent that some households may be employing these instruments to purchase a home that would otherwise be unaffordable, their use is beginning to add to the pressures in the marketplace."
Interest-only mortgages aren't even mortgages, strictly speaking. The "mort" in mortgage derives from the Latin root for "death" and refers to amortization, the slow extinguishment of debt that comes with monthly principal payments. Without amortization, debt is immortal, at least until the loan term expires. Then it has to be refinanced.
Interest-only loans are seductive because initial payments are lower than they would be otherwise.
Take a $200,000 loan at 5 percent. With interest only and not counting insurance, taxes or other items, your monthly payment would be $833. Amortize the same loan over 15 years and the payment nearly doubles, to $1,582. At 30 years it's $1,074, more affordable but still $241 more than the interest-only options, which could mean the difference between qualifying and not qualifying.
This being America, the land of instant gratification and endlessly delayed accounting, most interest-only mortgages come with another feature that make them look even sexier.
This is the adjustable rate. Borrowers lock in a relatively low interest rate for a fixed period - say, two or five years. But when the lock expires, the rate moves to whatever lenders are charging at the time, which could be much higher.
Increasing the risk, many interest-only loans start to amortize after the initial rate-lock period is over, which also increases the monthly payment. And the payment often rises even higher because the amortization period is compressed; you must hurry and catch up after having skipped principal payments for years.
Lenders call the triple-whammy "payment shock." It could crank up monthly payments well past 50 percent, and some investors who buy mortgages after they're issued by places such as First Maryland worry borrowers won't be able to handle it.
"I was talking with an investor this morning who was saying, `There's nothing to buy,'" recounts Susan Kulakowski, a vice president at Dominion Bond Rating Service in New York, which follows mortgage securities. "I don't want to buy these interest-only loans," the lender told her. But there weren't many alternatives.
That lender seems sane. Others don't.
Nationally, interest-only loans have popped from 2 percent of new mortgages in 2001 to 19 percent in the first quarter, according to LoanPerformance.
In Maryland they've gone from 1 percent to 24 percent, and in metro Baltimore they grew from 1 percent to 18 percent.
It's no accident that no-principal loans are concentrated in areas where home prices have soared, that they're closely associated with what many are calling a bubble.
Interest-only loans are an effect of high home prices, as buyers stretch to swallow large pieces of debt. But they're also a potent cause, luring marginal purchasers into inflated markets to bid prices even higher, so that loans for tomorrow's buyers will be even bigger and riskier.
Greenspan is worried. We should be, too.
Top states in percentage of mortgages that were interest-only in the first quarter.
1. Arizona 34%
2. Colorado 31%
3. California 30%
4. Washington 28%
5. Virginia 27%
6. Nevada 24%
7. Maryland 24%
8. Georgia 20%
9. Oregon 19%
10. Minnesota 19%