The Consumer Federation of America released the results of a new study this morning called “Exotic of Toxic? An Examination of the Non-Traditional Mortgage Market for Consumers and Lenders.” The CFA analyzed borrower and loan characteristics of more than 100,000 mortgages originated between January and October 2005.

The results aren’t that startling to anyone watching the mortgage industry with anything more than a passing glance: If you’re taking out a non-traditional, riskier mortgage such as an interest-only loan or a pay-option adjustable rate mortgage (ARM), you have less than stellar credit, and you’re less wealthy than borrowers who use conventional 30-year or 15-year fixed rate mortgages.

Here are some of the key findings of the study:

  • More than one-third of interest-only borrowers earned below $70,000 annual. About 35 percent of pay-option borrowers earned under $70,000 per year.

  • African Americans and Latinos were more likely to receive pay-option mortgages. Latinos were twice as likely as non-Latinos to get pay-option ARMs. African Americans were 30 percent more likely to get them.

  • African Americans were more likely to receive interest-only loans than non-African Americans.

  • More than half of pay-option borrowers and 38 percent of interest-only borrowers have credit scores below 700. More than a fifth of pay-option borrowers had credit scores below 660.

  • The majority of non-traditional mortgages were used to purchase homes. Nearly 80 percent of interest-only mortgages and 57.5 percent pay-option ARMs were used to buy homes.

The problem with using non-traditional mortgages to buy homes is that homeowners could be vulnerable to payment shocks when the loans adjust. Check this out: A $200,000 home with an interest-only ARM would see the monthly payment rise 54 percent if the interest rate goes up from 5 to 6.5 percent on the loan. A $200,000 home with a pay-option ARM would see the monthly payment skyrocket by 123 percent.

“Non-traditional mortgages are more complex than your parents’ home loan and some highly leveraged or unsophisticated consumers could end up learning that the mortgage that helped them buy their home was a ticking time bomb that destroyed their finances for years,” said Patrick Woodall, Senior Researcher for the CFA.

Who’s at risk? Let’s take a look at one city. Last year 49 percent of all mortgages originated in the Atlanta metro area were non-traditional loans like interest-only mortgages and pay-option ARMs. If this blows up, home prices are going to sink.

May 24, 2006