Understanding Mortgage Meltdowns

Borrowers who used alternative mortgages to finance homes during the housing boom have experienced rising foreclosure rates as housing markets have declined. Some types of alternative mortgages may have exacerbated price declines and damaged the finances of consumers and lenders. The use of mortgages with adjustable rates, zero down payment, interest-only, or negative amortisation features raise economic risk compared to traditional mortgages. Because some borrowers and lenders did not adequately evaluate these risks, housing finance markets have been hit with significant losses and financial markets have been in turmoil. Alternative mortgages offer some combination of adjustable rates, extremely low down payments, negative amortisation, and optional monthly payments. The prudent use of alternative mortgages offers benefits. For example, during periods of exceptionally high interest rates, adjustable rates may suit consumers expecting rates to fall. People whose incomes depend on commission or bonuses may be attracted to mortgages with flexible monthly payments. These benefits come with potential costs for the borrower and for the financial system. Adjustable rates shift the risk of rising interest rates from banks to borrowers. Low down payments increase the risk that borrowers will owe more than their house is worth if prices fall. A borrower owing more than the house is worth may be unable to sell or refinance the house. The use of alternative mortgages in these areas may have contributed to rising defaults and more volatile home prices. More than a trillion dollars of mortgages originated during the boom will reset their monthly payments by 2009.