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Housing bubble may lose some wind
Stricter OCC rules on exotic mortgages may help stabilize housing prices as fewer buyers qualify.
October 21, 2005: 4:25 PM EDT
By Shaheen Pasha, CNN/Money staff writer

NEW YORK (CNN/Money) - With the popularity of exotic mortgages, it's never been easier for homebuyers to afford their dream house even if it's out of their preferred price range.

But the increasing use of interest-only and option adjustable rate mortgages has put federal regulators on high alert. This fall, the Office of the Comptroller of the Currency, along with other financial regulators, will issue guidelines for mortgage lenders that could make lenders think twice before readily offering exotic mortgages to potential buyers.

Will the inability to gain easy access to these creative mortgage products finally help let some of the air out of the inflated housing bubble?

It's certainly a distinct possibility, said Andy Laperriere, managing director at ISI Group, a research firm.

"I think it will affect a meaningful amount of loans," he said. "It'll be enough to take the marginal buyer out of the hottest markets and therefore slowdown or even stop some price appreciation."

Experts certainly see some correlation between the availability of these products and the surge in housing prices. Laperriere added that in high-priced markets such as California and Washington, interest-only and option ARMs make up about 50 percent of the mortgages used to finance homes.

In a recent statement, Federal Reserve Chairman Alan Greenspan warned that the use of exotic mortgages could be pushing prices higher and may induce some home buyers to take on more risk than they can handle.

Greg McBride, senior financial analyst at personal finance site said "mortgage products with lower initial payments give you additional buying power at the front end of the loan and its one of the contributing factors" to the spike in housing prices.

Exotic mortgages only one factor in housing prices

But it's hardly the only factor. According to the National Association of Realtors (NAR), prices for existing homes nationally have climbed 13.6 percent in the second quarter from a year ago. Growth in the West outpaced the rest of the country with prices 19.5 percent higher. And some metropolitan areas such as Fort Myers, Florida and Phoenix, Arizona have seen a surge of over 45 percent and 47 percent respectively.

Walter Molony, spokesman for NAR, said the housing market's strength in the last few years has been the result of a simple supply and demand equation: with an improving job market and low interest rates, there were simply more buyers in the market and sellers could demand higher prices.

He added while there has been "an explosion in first time homebuyers using no-down payment loans" or other exotic mortgage products, he didn't think there was necessarily a direct correlation between the availability of flexible home financing products and the housing spike.

But there's no denying that exotic mortgages have climbed in popularity in tandem with the rise in housing prices. According to the Federal Reserve Board's latest quarterly survey of senior loan officers from July, nearly a third of respondents said that non-traditional mortgage products make up 5 to 16 percent of their dollar volume of residential mortgages while one bank said these products make up 50 percent of its dollar volume.

And more than half of respondents noted that the share of mortgage originations accounted for by non-traditional mortgage products had been higher over the past 12 months than over the previous 12 month period.

Dean Debuck, a spokesman for the OCC, which regulates financial institutions, said the organization will issue guidance for mortgage products, adding that growth in the industry has uncovered "some things that need to be fixed." While he declined to comment on the specific guidelines, he said the OCC is focused on "safety, soundness and good risk management."

Financial analysts expect the OCC to set specific credit-worthiness standards to prevent people from over-stretching themselves into debt and make sure that these products are aimed at individuals that are capable of repaying their interest only and option ARM mortgages when interest rates climb and their monthly payments increase significantly.

Prices may stabilize

The new standards are likely to take some marginal players out of the market and may make sellers reconsider their exorbitant asking price as interest rates rise.

"You're going to see a pullback in prices as inventories grow," said Neil Garfinkel, a real estate attorney at Abrams Garfinkel Margolis Bergen LLP. "It won't be a quick turnover, but with fewer willing buyers, houses will be on the market longer and sellers' expectations will have to change."

But don't expect a free-fall in housing prices, experts said.

Ellen Bitton, president and chief executive of Park Avenue Mortgage Group, said the market is more likely to undergo stabilization rather than any major decrease in valuation.

"People who have only been looking at the real estate market in the last few years think prices have to increase by 10 to 20 percent a year," she said. "But that's a frenetic market, not a normal market."

She estimated that housing prices would return to a more stable 3 to 5 percent growth rate once it returns to a buyers market.

"But we have a way to go before we see that," she added.


Mortgage rates are on the rise. Click here to find out more.

Owning a home may not be as tax-friendly going forward. Click here for that story.  Top of page

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