Bruce Bartlett

Over the weekend, Federal Reserve Chairman Alan Greenspan warned that those actively speculating in the booming housing market should be very careful.  What goes up fast can come down just as fast.

 A key factor underpinning the surge in housing prices is a belief by lenders that risks have fallen.  As a consequence, they became more willing to lend to people on terms that they would have been unwilling to accept in the past.  This made mortgages available to people who would have not previously have qualified and bigger mortgages for those with good credit.

 A new report from SMR Research found that in the first half of this year, 38.1 percent of homebuyers financed more than 95 percent of their purchase.  In other words, they bought with less than five percent down.  The percentage of those doing so has increased from 34.1 percent last year and 30.6 percent in 2000.

 The same report found that 66.3 percent of homes purchased in 2005 involved borrowing more than 80 percent of the home’s value, up from 60.9 percent in 2000.  Historically, loans with less than 20 percent equity have been considered risky.

 An important reason for the increasing loan-to-value ratio is the proliferation of what are called “piggyback” loans.  Basically, a borrower takes out two mortgages simultaneously—a first mortgage and a second, piggyback mortgage on top.  The first mortgage will be what is called “conforming,” which means that it can easily be resold on the secondary market.  The balance might be in the form of a home equity loan or credit line that is used to make the initial purchase, rather than taken out afterwards.

The effect of breaking the total mortgage into two parts like this is that it allows people to borrow more money with lower incomes than would be possible if they had a single “jumbo” loan, as would have been the case in the past.  According to a recent report from PMI, a mortgage insurance company, in many hot housing markets 60 percent of home sales are financed with piggyback loans.  The size of piggyback loans is also increasing rapidly, from $37,757 in 2001 to $51,617 in 2004.

Such loans are riskier than traditional loans because there is less equity backing the loan, making lenders more vulnerable to loss in the event of an economic downturn or falloff in home prices.

Bruce Bartlett

Bruce Bartlett is a former senior fellow with the National Center for Policy Analysis of Dallas, Texas. Bartlett is a prolific author, having published over 900 articles in national publications, and prominent magazines and published four books, including Reaganomics: Supply-Side Economics in Action.

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