One of the customary mechanisms for inflating the Great Housing Bubble was the overall use of exotic loan terms along with interest-only and negative-amortization adjustable rate mortgages. The request for retrial of interest-only and negative-amortization loans is the lower payments they offer, or their capability to finance larger sums of money with the same payment. These loan terms are unstable, and they may not be offered to hereafter buyers. If these loan programs were eliminated, the financing sums would decline, and home prices would decline along with them.
Adjustable rate mortgages are very risky; it is a risk that has been forgotten, ignored, or not understood by a great many buyers. In an era of steadily declining interest rates, the risks of adjustable rates mortgages do not become problems and many forget (or never realized) the risks were there. Once prices decline to a point where the loan balance is greater than the value of the property, mortgage holders are unable to refinance when their mortgage reset comes due. Most often this will corollary in a foreclosure. In fact, this is the customary mechanism of the decline, and it will also prevent any meaningful appreciation for years to come.
Of all the factors that contributed to the inflation of the Great Housing Bubble, the negative amortization loan with its offers of very low preliminary payment rates was the customary factor that pushed prices higher than anything could previously imagine. Toxic loan products, or as the lending industry likes to call them, affordability products, distort the customary portion of the debt-to-income ratio. The debt-to-income ratio is calculated with an assumption of a 30-year fixed rate mortgage, when in reality, borrowers were using interest-only and negative amortization loans to keep their debt-to-income ratio to manageable levels.
Since adjustable-rate mortgages of all types performed poorly while the collapse of house prices, and in particular the negative amortization loans, it is likely these loan terms will be curtailed or eliminated in the future. These loans are inherently unstable and prone to high default rates due to the escalating payments that can, and often do, corollary from their use. The overall use of these loans destabilizes home prices by detaching them from underlying valuations. The use of these loans creates the very conditions in which they poorly perform.
People who purchased while the bubble rally at inflated prices using these loan terms were risking that these terms would always be ready to buyers in the shop because without these terms, hereafter buyers would not be able to finance the inflated sums primary to allow a bubble rally buyer to get out with a profit. Without these exotic loan terms the Great Housing Bubble could not stay inflated.
future Loan Terms and Residential Real Estate Markets