Millennials who watched their parents or grandparents struggle with toxic mortgages, short sales and foreclosure might be reluctant to buy a home and get a mortgage themselves. But most of those bad old loans are gone, and while real estate is never risk-free, today’s traditional terms, strict guidelines and government-mandated forms can help millennials become safe and successful homeowners.
The differences are dramatic, said Greg Cook, a senior loan officer for Platinum Home Mortgage in Temecula, Calif.
One of the riskiest old loans was known as the payment-option mortgage because it gave borrowers a choice of four monthly payments: a minimum payment, interest-only payment or 15-year or 30-year full amortizing payment, Cook said.
“It was a problem because almost everybody took the path of least resistance and said, ‘Let’s make the minimum payment.’ As a result, the loan balance got bigger.”
This increase is known as negative amortization. When house prices depreciated, borrowers found themselves upside-down, owing more than their homes were worth. Many stopped paying and let banks foreclose.
Today, negative amortization loans are exceptionally rare, if they can be found at all, because of a federal regulation that grew from the housing crash: the qualified mortgage rule.
Lenders get special protections when they make qualified mortgages — and qualified mortgages must be fully amortizing, which means the payment must include enough interest and principal to pay off the loan over the term. Negative amortization isn’t allowed.
Interest-only loans allow borrowers to make payments that include interest, but not principal. When the borrower makes the minimum payment, the loan balance doesn’t increase, but it doesn’t decrease either.
Where many borrowers “went sideways,” with this type of loan, to use Cook’s words, is that after a specified number of years, the loan typically is recast and the borrower must make principal and interest payments to pay it off, but over a shorter term. That results in a much larger monthly payment that caught many borrowers by surprise.
Michelle Velez, a mortgage sales manager in San Mateo, Calif., said some interest-only loans are available today. They typically require the borrower to qualify based on the fully amortized payment instead of the interest-only payment.
Another type of dicey mortgage was the so-called stated-income loan, which originally was intended to help borrowers who were self-employed and had excellent credit and a large down payment.
Since the borrower’s income was stated on the loan application with little or no verification, borrowers and loan officers often felt free to claim whatever income they wanted.
“They started to reduce the [required] down payment and credit score, and that’s when it became the ‘liar loan,’ ” Cook said.
Many borrowers lied about their incomes, qualified for loans, but couldn’t make the payments or made only the minimum if their loans had that option.
Nowadays, virtually all borrowers must provide income documentation, typically W-2s for employees and tax returns and financial statements for self-employed people.
Lenders typically require borrowers to pay for an appraisal of the home they want to buy to confirm that its value supports the purchase price. If the appraisal is “low,” the lender might not approve the loan and the deal might fall through.
Before the financial crisis and subsequent regulations and changes in the real estate business, brokers and agents could pressure appraisers to make sure valuations were never “low,” regardless of the homes’ true values.
Today, appraisers are kept at a professional distance from brokers and agents to help protect them from this type of undue influence.
Loan estimate form
Given all this, it’s no wonder millennials want mortgages that are safe and predictable. “In the back of their mind, sometimes they think mortgages are evil,” said Fred Kreger, certified mortgage consultant for American Family Funding in Santa Clarita, Calif.
This, too, could be changing due in part to the new Loan Estimate and Closing Disclosure forms designed, consumer-tested and, as of Oct. 3, 2015, mandated by the federal government. The Loan Estimate form, Kreger said, “clearly explains everything [borrowers] are getting into, as opposed to in the past when they weren’t necessarily explained to upfront.”