Peaking rates pique interest

More and more, Bob Hyatt has become a sounding board for his clients' horror stories.

There's the tale of $20,000, borrowed a few years ago on a variable rate home equity line of credit. When rates rose, the borrower transferred the debt to a new loan. And when that loan became unaffordable, it was shifted to yet another lender.

By the time the man came to Hyatt for help, his debt had been swollen by loan origination fees and prepayment penalties to $41,000.

Another couple had borrowed $90,000 on a 30-year mortgage at a fixed rate of 8 percent. But when interest rates dropped, the pair responded to an advertisement and refinanced into a super-low, adjustable rate mortgage.

The jaw-dropping initial interest rate lasted only a year. It now has been adjusted upward twice, to nearly 10 percent. With credit insurance and fees wrapped in, the couple's debt is up to $116,000.

"So those are the kinds of issues we're seeing," says Hyatt, development director for the Neighborhood Economic Development Corporation, a Eugene-based agency that advocates home ownership.

"It breaks our hearts, because we're here for home ownership," he says. "A home is supposed to be a safe haven."

It's getting increasingly scary for those in the most vulnerable debt positions - holders of adjustable rate mortgages, variable rate home equity lines of credit and high credit card balances - as the federal government continues to fight to keep inflation in check by raising base interest rates.

"The whole purpose, as they start raising those rates, is that they're hoping to hold down certain segments (of the economy)," says Terry Gent, executive vice president and regional manager for commercial lending at Umpqua Bank. "But for those who haven't planned, it can impact them pretty heavily."

The Federal Reserve Board's Open Market Committee has raised short-term interest rates by a quarter-point each of the last 12 times the committee has met, dating to June 2004. The result has been a jump in the Fed Funds Rate - the rate at which banks make overnight loans to each other - from 1 percent prior to the June 2004 committee meeting to 4 percent following a meeting last month.

Fixed rate mortgages, the most common form of home financing, are not directly affected by the short-term rate increases. Rates for 30-year and 15-year mortgages are much more closely tied to long-term government bond yields.

But adjustable rate mortgages - ARMs - are tied to various short-term indexes and are much more sensitive to interest rate moves by the Fed. A rising interest rate environment affects both the original rates charged to ARM borrowers and the adjusted rates that become effective after an initial period of the loan.

"I do feel there are a lot of people out there who are even paying prepayment penalties (to get out of ARMs) because they're so afraid of what rates are going to be doing," says Travis Winslow, a loan officer at Grandeur Financial, a Eugene mortgage brokerage.

Winslow says that he's been selling mortgages for five years now - throughout the recent low interest rate boom. Clients who opted for adjustable rate mortgages early on got pleasant surprises when their initial loan periods expired, usually after two years, and their rates were adjusted downward.

In recent months, many holders of adjustable rate mortgages have sought to replace them with fixed-rate loans to avoid soaring interest payments.

But the ARMs have their place, Winslow says, because they often can be written for the full value of a home and are more accessible for those who wouldn't qualify for a more conventional mortgage.

Lenders don't want to hold loans that are for 100 percent of the value of the property, he says. But, he says, someone can use an ARM to buy a property with zero money down. Then, after a couple of years, the buyer has some equity in the property and can re-finance and get a conventional, fixed rate mortgage.

Scott Anderson, a Wells Fargo senior economist based in Minneapolis, says that ARMs have moved from a 19 percent share of the industrywide mortgage market in 2003 to 30 percent of all mortgages written this year. The percentage of ARMs is expected to drop to about 28 percent in 2006, with many of those adjustable rate loans tailored to fit customers who still don't qualify for conventional mortgages.

Adjustable rate mortgages vary in the length of their initial rate periods and in the frequency of their eventual rate adjustments. Some even offer periodic adjustments to the length of the loan as an alternative to interest rate increases.

"You can't blame the mortgage industry for trying to do some of those things," Anderson says. "They're trying to keep the ball rolling. They've been trying to keep it going as long as they could, and consumers have been willing to take on these risks."

RealtyTrac, an online marketplace for properties being foreclosed on, said last week in its Foreclosure Market Report for October that foreclosures had increased by 18.6 percent since its September report. The October rate - one foreclosure out of every 1,422 households - was the highest this year, according to the agency.

But Anderson says that he doesn't expect rising interest rates to cause significant problems for lenders or the overall economy, even if some consumers "at the margin" are hurt by their increasing debt.

He points out that the rates on 30-year, fixed rate mortgages - the staple of the home loan industry - are expected to reach a nationwide average of 6.3 percent in 2006. And that's still low from a historical perspective.

Those are the types of loans that Wells Fargo and most major banks have recommended for their customers throughout the surge of home buying and refinancing in recent years, he said.

"It's more of the niche players that have made a bundle on the refinancing," Anderson says. "They're looking at other growth avenues, and they've gotten into these aggressive lending techniques."

In addition to a slow decline in ARMs, he expects a more rapid drop-off in home equity loans and lines of credit, along with other consumer borrowing.

"As home equity growth slows, home equity lines of credit are going to slow," Anderson says. "And with the Fed hiking rates now, it becomes more expensive to borrow for everyday things."

Home equity lines of credit and credit cards are even more susceptible than ARMs to rate hikes by the Fed, because both are tied to the prime rate - a consensus of the loan rates charged by the nation's largest banks to their most-favored clients.

The prime rate moves up and down in reaction to interest rate decisions by the Fed.

"ARMs have traditionally not been as favored in Oregon as they have been in other parts of the country," says Gent, at Umpqua Bank. "But people are leaning on credit cards pretty heavily. And if they're leaning on their credit cards, there are not a lot of other resources available to them."

At Eugene's Neighborhood Economic Development Corporation, Hyatt figures he's just seeing the tip of the iceberg of those who will be looking for ways to escape their increasingly expensive debts.

"With interest rates changing, it's going to accelerate the process," he says. "I'm anticipating, just based on what's going on so far, that we're going to get a lot more inquiries."

What are people saying about mortgages today:

Rates on 30-year mortgages edged down last week to a seven-month low. Mortgage-giant Freddie Mac reported Thursday that 30-year, fixed-rate mortgages fell to 6.3 percent, down slightly from 6.31 percent two weeks ago. It put rates at the lowest level since they were at 6.24 percent the first week of March.

Bank of Hawaii, Central Pacific Bank, Territorial Savings Bank and Wells Fargo Home Mortgages all cut their 30-year mortgage rates to 5.75 percent this week.

Most people think of a mortgage as a means to an end. After all, you buy a house, not a home loan. But a mortgage is much more than the path to homeownership. It is a financial instrument that must be managed, just like any other financial investment.