The Dangers of Exotic Loans in San Diego

Submitted by Rich Toscano on January 1, 2006 - 9:56pm

The San Diego Union-Tribune has run a really good article on the risks of creative mortgages. As a matter of fact, my eyes nearly welled up with tears as they beheld the following paragraph (emphasis mine):

One product that concerns federal regulators is the pay-option ARM. It is "one of the most aggressive loan products out there to countermand the prices of homes," Smith [president of the local chapter of the California Mortgage Brokers Association] said. It gives borrowers the flexibility to choose how they make monthly payments. They can make a low payment that allows the principal to grow, increasing the amount owed. The theory behind that choice is that home appreciation will outpace rising debt. "That is a calculated gamble a lot of people have taken."

The openly speculative nature of exotic mortgages is a topic I've harped on for ages. And yet this is the first time I recall a mainstream news source coming out and just laying it on the table like that. It's good that the subject is finally getting the attention it deserves, because the ubiquity of these loans poses a major risk to San Diego's beloved Soft Landing.

After all, Soft Landing advocates insist that prices will flatten out for the next several years because (barring a recession) nobody will be forced to sell. And yet, as the article notes, many borrowers have put themselves in positions where they are dependent on continued rising prices just to stay solvent. In other words, prices may flatten for a while, but soon enough many homeowners will be forced to sell. And that's when home prices will likely start to fall substantially.

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