They were the villains of the housing crash. Federal regulators called them toxic. Now interest-only mortgages are making a comeback, but these are not the loans of yesteryear or yester-housing booms.
"I think it's opening the door back to responsible lending, giving people choices," said Mat Ishbia, president and CEO of Michigan-based United Wholesale Mortgage, the second-largest lender through brokers in the nation.
The company announced Monday it is now offering interest-only loans through brokers, with significant safeguards. Borrowers must put 20 percent down, ensuring that they have the "skin in the game" that so many did not during the heady days of the housing boom. They must have at least a 720 FICO credit score, which is well above average, and they must qualify on what the payments will be once they're adjusted higher, not at the starter rate.
"These people can afford these mortgages. They're savvy homeowners," said Ishbia. "We're giving them the choice. It is no more risk to us. We actually think it's less risk."
United Wholesale Mortgage does not hold the loans but sells them to investors. Fannie Mae and Freddie Mac, the government-backed mortgage giants, do not buy these types of loans.
The mortgage begins as a five-year adjustable-rate product. Without paying principal, a borrower using, for example, a $300,000 mortgage, would start at 4.125 percent today, the same as a 30-year fixed. Without paying principal, however, the borrower would save $420 per month.
The interest rate can then adjust higher after five years, depending on market rates, but borrowers for this product are underwritten at a rate above 6 percent to ensure they could handle that adjustment. Borrowers are also required to start making principal payments after 10 years; of course they can also refinance the loan whenever they want.
In 2013, the Consumer Financial Protection Bureau issued rules to protect consumers from what it deemed "irresponsible mortgage lending." So-called qualified mortgages under the new regulations would give lenders certain protections, should the loans go bad. Under the QM rules, according to the news release at the time, there would be:
No toxic loan features: A qualified mortgage cannot have risky loan features, such as terms that exceed 30 years, interest-only payments, or negative-amortization payments where the principal amount increases. In the lead up to the crisis, too many consumers took on risky loans that they didn't understand. They didn't realize their debt or payments could increase, or that they weren't building any equity in the home.
Interest-only loans therefore fall outside the definition of a qualified mortgage. During the housing boom, they were used to help borrowers buy homes they really couldn't afford. Now, more lenders are starting to do them again, but with much tighter restrictions. They are mostly offered to high net worth individuals in the jumbo loan category, and banks hold the loans on their balance sheets.
Wells Fargo confirmed it does offer interest-only loans that it holds in its portfolio.
"If we feel the borrower has the ability to repay but they're not necessarily a qualified mortgage for some reason, we can still do the loan and we will do so," said Franklin Codel, head of mortgage production for Wells Fargo Home Lending, in an interview in late 2013.
This offering by United Wholesale Mortgage is designed to provide the product to a wider group of consumers through brokers. Consumer watchdogs are concerned that with a wider reach they will be used more for refinances, which could create a problem, given how quickly home prices are rising today.
"The value of the home is perceived to be worth more than what it is, so if you're using it for a refinance, you're not actually requiring cash out, you're using equity from the home," said Mitria Wilson, vice president of government affairs at the Center for Responsible Lending. "There is always the chance that the house is not worth the value that's stated."
Wilson concedes that the loans will not be nearly as risky as they were during the last housing boom, before all lenders were required to ensure borrowers' ability to repay on all loans.
"It's a far riskier product, a product that some consumers will be able to utilize beneficially, but by and large, most consumers do better with a 30-year fixed-rate mortgage," added Wilson.