In July, NTIC released its annual study of foreclosure starts for the city of Chicago. Foreclosure starts increased by a modest 1% in 2005; however, foreclosure starts on conventional loans with low initial interest rates increased 43% and foreclosure starts on young loans (less than 24 months old) with low initial interest rates and ARM and/or balloon payment features increased 152% in 2005.

NTIC began tracking foreclosures in Chicago in 1999. Through this effort, NTIC was able to document the relationship of high cost sub-prime loans and foreclosures during the sub-prime explosion of the 1990s. In recent years, NTIC’s research showed the decline of foreclosure starts following enactment of Illinois’ anti-predatory lending regulations and its High Risk Home Loan Act. These reports documented the impact of law and community programs to reduce foreclosure.

The recently updated analysis shows that foreclosures are once again on the rise but high cost loans are no longer to blame. The rise in popularity of what some call “exotic” loan products, such as interest-only loans, teaser-rates and option ARMs (adjustable rate mortgages) has been widely reported.

Traditional ARMs benefit borrowers by reducing monthly payments. A 1-year, 3-year or 5-year ARM refers to the amount of time during which the interest is fixed. After the period elapses the rate adjusts according to a formula which may be based on some index of mortgage rates (like the prime rate or Treasury rates).  As the interest rate rises, monthly payments also rise.

Recently variations have become popular. These variations aim to give borrowers more flexibility and lower payments than traditional ARMs. In some cases the payments are so low that, not only will the loan never actually be paid off, but the loan balance may actually grow. As a result the borrower may not build equity and may fall ever deeper in debt.

“Exotic” loans were developed for borrowers with very specific needs, not the average homeowner. Instead they may be subject to a substantial payment shock and fail to build enough equity to weather a financial crisis. Traditional ARMs and some exotic loans often promise initial benefits that fail to hold over time.

NTIC’s analysis shows the effect this is having on Chicago foreclosures.  The report shows foreclosures started on loans with ARM characteristics are skyrocketing while foreclosures started on high cost loans regulated by the state law  continue to fall. Borrowers are also falling into foreclosure faster as more and more young loans are represented.

Why is this happening? Unfortunately, unscrupulous brokers can mislead borrowers into agreeing to loans that are not in their best interest.  For decades, NTIC collected stories of borrowers who were sold over-appraised home, homes with major defects or were misled about the terms of their loans or the fees they would have to pay.

The finance industry has, in effect, blamed borrowers, claiming that consumers should take responsibility for their financial education. But in reality, no amount of general consumer education will equip borrowers to weigh all the options during this very complex transaction. Highly trained professionals who may or may not have their best interest at heart have a large advantage.

For two decades, NTIC has produced research, policy analysis and public and corporate policy changes designed to illuminate barriers to homeownership and assist people to achieve the American Dream. We have worked on both sides of the equation: helping people to buy homes and helping them stay in them.