July 14, 2005

Housing is hot, but types of loans seen cooling

By Julie Haviv

NEW YORK (Reuters) - The U.S. housing market is
persistently hot thanks to low interest rates and seemingly
unstoppable demand, but the loan industry that has been fanning
the flames is seen to be cooling off.

That's what housing market analysts and economists are
saying about mortgage lenders, predicting that progression in
their loan product innovation has entered its final stage.

"While I don't think they are at the point of giving out
free toasters to get customers, loan creativity appears to be
at a maximum level," said Douglas Duncan, chief economist at
the Mortgage Bankers Association, an industry trade group.

A few years ago most borrowers chose plain-vanilla
fixed-rate mortgages that matured in 15 or 30 years.

But incessant home price appreciation has driven an
increasing number into more affordable options like adjustable
rate mortgages, or ARMs, which offer lower initial payments.

The share of outstanding mortgages that are ARMs has grown
to 1 in 3 from 1 in 10 in 2001, research by Bear Stearns said.

"Lenders have introduced a much broader line of loan
products over the past few years to compete for a shrinking
pool of business," the MBA's Duncan said.

Loan refinancing has dropped significantly. The MBA's
closely watched refinancing index has plunged to 2,554.3 from a
record peak of 9,977 in May 2003.

"There is virtually no obstacle to get approved for a loan
right now, but we are also dealing with an industry that is
going to shrink in volume over the next few years, so lenders
are fighting aggressively for customers," said Anthony Hsieh,
president of LendingTree.com, an online facilitator which
matches consumers with lenders competing for their business.

In his three-year economic forecast released this week, the
MBA's Duncan said he expects U.S. existing home sales to
increase 2 percent to a new record in 2005, but pull back by
about 3 percent in 2006 and decline another 2 percent in 2007.

New homes sales will also rise by nearly 2 percent to a
record high in 2005, and slip by 4 percent in 2006 and about
another 3 percent in 2007, he said.

"Product innovation may have run its course," said Hsieh of
LendingTree.com, which works with some of the largest U.S.
mortgage originators, such as Citibank, Wachovia and Bank of

Bear Stearns says analysis of "serial" refinancers shows
the evolution of loan products. Borrowers typically start with
30-year amortizing loans then move into amortizing ARM hybrids,
which are loans that carry an initial fixed rate for a set time
period of time but that move to a floating rate at maturity.

After the hybrid ARM loan, consumers tend to refinance into
interest-only products, followed by an option ARM product.

With an option ARM a borrower can choose payment options,
including paying no principal and less than the interest due
each month. A "negative amortization" loan can end up growing
in size during its term.

"No other product can compete with the low monthly payment
of an option ARM," Bear Stearns said.

Even interest-only loan products fall short of option ARMs,
the firm said. For example, with the assumption of a standard
1.5 percent teaser rate offered on most option ARMs the
break-even interest-only rate would be 4.14 percent, well below
any hybrid or fixed mortgage rate currently offered.

Bear Stearns' conclusion: it is the end of the road in the
mortgage affordability cycle.

But not everyone believes the end is near for mortgage
lenders. Some say as long as profits stay plump, lenders will
develop new loan types.

"They have been creative and they will continue to be
creative as long as mortgage delinquency rates remain low,"
said Celia Chen, director of housing economics at Economy.com,
a consulting firm.