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| Accredited Home Lenders said last week it would close most of its mortgage business to survive the subprime turmoil. Mike Blake/Reuters |
Subprime loans face big hikes
Borrowers with poor credit ratings may see rates jump to 10 percent or more.
By Ron Scherer | Staff writer of The Christian Science Monitorfrom the August 30, 2007 edition
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New York - Millions of homeowners around the nation are now getting the news in the mail: The interest rate on their home loans is going up, possibly to double-digit levels.
The hardest hit are expected to be people who have less-than-stellar credit and cannot afford to make the new payments. An increase of several hundred dollars a month will force them either to get relief or to default. The prospect of significant and growing losses has already rocked Wall Street and shaken up the broader mortgage markets. And, concerned about the human suffering, policymakers are already searching for ways to help people out.
"The meltdown in the subprime market is the biggest threat to the housing market and the broader economy," says Mark Zandi, chief economist at Moody's Economy. com. "It is at the vortex of the problem."
Over the next several months, banks will be changing the "teaser rates" that homeowners received two years ago.
The peak for resetting loans will be in October, when the rates on some $50 billion worth of mortgages are likely to rise by 2 percentage points or more. This could mean a rise of several hundred dollars a month for many borrowers.
For example, on a $210,000 loan balance (the average subprime amount in 2006), the additional 2.5 percentage point increase on the interest rate adds about $4,560 a year, or about $380 a month, estimates James Kragenbring, senior investment officer at Advantus Capital Management in St. Paul, Minn.
That means the median household would have to devote an extra 9.5 percent of income just to pay the extra interest.
"Given the debt-to-income ratio of the typical subprime borrower at the time they received their loan, it is unclear where the extra cash flow will come from," says Mr. Kragenbring.
Interest costs rise faster than pay
It probably won't come from a pay raise, if recent trends continue. Last year, median household income rose 0.7 percent to $48,201, the US Census Bureau reported Tuesday.
"If mortgage payments are rising faster than the 0.7 percent average growth rate, then they are rising faster than incomes and that could create problems," says Chuck Nelson, of the Census Bureau.
It's already creating problems in Buffalo, N.Y.
"If the borrower is on Social Security, the most their income is rising is 3 percent a year and the mortgage payments are rising much faster than that," says Carol Brent, staff attorney of Legal Services for the Elderly.
She says she has clients whose monthly income is $800 a month but whose mortgage payments have now mushroomed to $500 a month. "No one looked at the affordability factor."
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