- The Washington Times - Wednesday, May 4, 2005

The housing boom spread to an unprecedented 55 metropolitan areas last year, including several exurbs of Washington, aided by an explosion of risky lending practices, the nation’s chief bank insurer said yesterday.

All of the cities identified by the Federal Deposit Insurance Corp. as having home price appreciation of 30 percent or more beyond the rate of inflation in the past three years are in the Northeast, California and Florida.

The Washington boom — some would say “bubble” — appeared to spill over for the first time into Winchester, Va., Baltimore, Virginia Beach and other nearby areas, aided by increasingly easy credit for investors, subprime borrowers and buyers having difficulty stretching their incomes to meet soaring monthly mortgage payments.

“History clearly shows that housing booms don’t last forever,” and “the manner in which they end matters for mortgage lenders and borrowers alike,” said Cynthia Angell and Norman Williams, agency economists and authors of the study.

Most previous housing booms, including one in the late 1980s in Washington, did not end in busts, defined as a drop of 15 percent or more in house prices.

Rather, they ushered in long periods of housing price stagnation that — while uncomfortable for homeowners and lenders — enabled household income growth to catch up with soaring home valuations, the agency said.

But the current boom may prove to be an exception because of a proliferation of lending risks, it said.

Subprime mortgages surged by 20 percent last year, with the majority of those loans to home buyers with poor credit histories featuring onerous repayment provisions such as floating interest rates and prepayment penalties, the agency said.

Subprime mortgages are considered the most likely to go into default, partly because their stringent lending terms can make payment even more difficult when individual or economic circumstances take a turn for the worse.

The Federal Deposit Insurance Corp. is responsible for rescuing or dismantling any national banks that might go under as a result of holding portfolios of nonperforming mortgages — an eventuality that few are predicting currently.

While the rates on 30-year mortgages remained at less than 6 percent last year, near their lowest in a generation, almost half of all home buyers resorted to lower-rate adjustable mortgages (ARMs) to pay for increasingly unaffordable homes, the agency found.

“These trends suggest that highly leveraged borrowers are increasingly taking on interest-rate risk as they stretch to afford high-cost housing,” the authors said.

The authors singled out interest-only loans and option ARMs, both of which are designed to minimize initial mortgage payments by eliminating principal repayment, as an “evolving trend that has not been tested in a housing market downturn.”

Such loans, which can explode in cost after five to 10 years, “increase leverage and expose owners to large jumps in monthly interest payments as interest rates rise,” the agency said.

“While financially savvy borrowers using these products are more likely to be prepared” for a surge in costs, the authors said, “these higher risk ARMs are increasingly being offered to borrowers seeking low- or no-documentation loans and to those with blemished credit histories.”

The agency noted a surge in mortgages taken out last year by investors buying second homes — a phenomenon that many economists say is evidence of a housing bubble.

Nationwide, investors accounted for 9 percent of mortgage originations, up from 6 percent in 2000. In Washington and other booming areas, the rate was as high as 19 percent.

An uncounted number of other investors are buying second homes by taking out mortgages on their primary residences, financial analysts say, while other wealthy households are tapping into their burgeoning home equity to finance loans for a variety of investments.

The heightened investor activity signals a “speculative” presence in the housing market that increases the risk of a downturn, the insurance agency said.

“Investors are less loss-averse than owner-occupants, and thus more likely to sell precipitously in a declining market, thereby aggravating any existing downtrend in home prices.”

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