Teaser-rate mortgages to jolt poor with big bill


First it was terrorism. Then a stock market crash. Then rising energy prices.

Are you ready for the next obstacle for consumers?

Millions of cheap, teaser-rate mortgages that people took out a few years ago, when interest rates were rock-bottom, are about to get much more expensive.

More than $1 trillion in mortgage debt costing only 4 percent or so - rates locked in three years ago - is about to soar in price to nearly 8 percent in some cases.

With consumers already stressed by credit card payments, high gas and electric prices and meager raises, economists worry that the mortgage changes will put a new crimp in retail spending.

"It just suggests that consumers, particularly lower-end consumers, are going to be more stretched when these loans reset, with potentially negative implications for spending growth," says Scott Hoyt, director of consumer economics at Moody's Economy.com.

For somebody with a $150,000 mortgage payable over 30 years, a pop from 4.5 percent to 7.5 percent would mean a payment increase from $760 to $1,050. That's nearly $300 removed from a household's free monthly cash flow, all at once.

This will happen because of a relatively new breed of loan - the hybrid adjustable mortgage. Traditional adjustable mortgages reset every six months or a year, which allows borrowers to adapt incrementally if rates are in a long-term rising trend.

But with hybrid loans, rates are frozen at below-market prices for three years or five years, after which they adjust to prevailing levels. If rates keep rising during the freeze, the pain comes all at once three or five years later, when the freeze expires.

And rates have been steadily increasing since they hit historic lows between 2002 and 2004 and prompted a refinancing craze. Short-term rates, the kind that govern adjustable mortgages, have risen especially steeply as the Federal Reserve tightened the money supply at 15 successive meetings since 2004. (Full disclosure: I have a non-hybrid, home-equity line of credit linked to short-term rates.)

For holders of hybrid mortgages, the result won't be too different from what will happen when six-year caps on Baltimore Gas and Electric prices go away July 1.

Pent-up increases arrive with a crash - with the difference that the planned $743 increase in the average annual BGE bill looks tame compared with what will happen to some mortgage borrowers.

Rates on some mortgages could rise as much as 5 percentage points, says Mike Fratantoni, a senior economist with the Mortgage Bankers Association.

And that's not all. Many households took out "interest only" mortgages in which no principal was repaid during the three- or five-year rate cap. These were especially popular in Maryland. Now, not only do the mortgages' rates rise; payments go even higher because borrowers must begin repaying the face amount of the loan.

A fourth of the $9 trillion in outstanding mortgage loans are adjustable. About half of those are hybrids. But adjustable notes are more prevalent among bigger, riskier borrowers, so more dollars are at stake than is indicated by simply counting adjustable loans.

Deutsche Bank AG estimates rate caps will expire on $300 billion in hybrid-adjustable mortgages this year and close to $1 trillion in 2007. Even with only a 3 percent rate increase and not counting new principal payments, that's $40 billion swiped from consumer spending power.

The most worrisome scenario is that significant numbers of homeowners will default on their loans. Adjustable mortgages account for close to 60 percent of the loans made to people with sub-prime, less desirable credit. They're especially vulnerable to swelling monthly payments.

Economy.com's Hoyt doesn't expect resetting mortgages will stop consumers cold.

"We don't view this as catastrophic for spending - just a restraint on growth," he says. "Clearly labor markets are strengthening. The unemployment rate's been trending down. As a result we've seen, while [there is] still fairly slow growth in most measures of wage rates, more people are getting jobs."

They'll need them, to pay off those loans. If the Federal Reserve's interest-rate increases finally slow the larger economy, higher mortgage costs could be one element making the slowdown worse than expected.


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