Experts everywhere have been slinging around a lot of blame for the mortgage crisis; one of the "culprits" has been interest-only mortgages. The problem with IO loans, analysts claimed, was that borrowers who chose to make an interest-only payment for five or ten years were unprepared for the inevitable increase in payment when the loan was re-cast to pay off completely in twenty-five or thirty years. And in a certain context, that makes sense -- if you can't afford the payments on a fully-amortizing thirty-year loan, why would you be able to repay that same amount over a shorter period once the interest-only period ends?

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For example, the interest-only payment on a $400,000 loan at 5% is $1,667 a month. The full payment is $2,147. And if the interest-only period is five years, the $400,000 balance must be amortized (paid off) over 25 years -- on year six, the payment increases by $672 from $1,667 to $2,338. An unprepared homeowner could find himself or herself unable to pay this much. Imagine that five years ago, before the recession, it was not unreasonable to believe that one's income over the next 60 months would increase significantly. If you made $5,000 a month back then (which would make a $1,667 payment doable but not a $2,147 payment), and you received a 5% raise each year, you'd expect your income to be about$6,400 a month by the time your payment increased.

But this expected regular increase in pay has not happened for a large portion of the population; in fact, many young hopefuls are unemployed instead of happily ensconced in a lucrative career.

Then, many others expected that their homes would increase in value and that they'd be able to sell at a smart profit by the time the expected payment increase hit, or that they'd be able to refinance to a new 30-year term or even a new interest-only loan. A $400,000 home that increased in value at 5% per year would then be worth over $500,000 by the time the mortgage changed.

And we know that for many this expected scenario did not materialize either. At worst case, there were folks facing diminished incomes and with homes worth much less than was owed on them.

But were the interest-only loans the cause of the debacle? What about resetting adjustable rate mortgages, which some have suggested were instrumental in bringing on the housing crisis? Or prepayment penalties, which have been blamed by legislators for keeping people in mortgages that they couldn't afford? New mortgage laws aim to keep loans with many popular features like these away from borrowers. Would such provisions have averted the housing crisis?

Apparently not, found San Diego State University's Michael Lea, who examined mortgage products in 12 different countries and found that mortgage design didn't necessarily lead to higher defaults elsewhere, even in those countries that had greater home-price volatility. The research concluded that underwriting practices which resulted in loan approvals not based on borrowers ability to repay the loans were the culprits, not loan provisions themselves.

For example, sensible underwriting would dictate that the borrower be able to handle the expected increased payment with current income. You don't give an unemployed person a loan based on the probability of him obtaining a job in the future, so you shouldn't grant a loan that is unworkable unless there is a future increase in income or assets. That's just silly.

So expect that proposed legislation won't do much to prevent the next crisis, but it will probably restrict your ability to get the most appropriate loan for your situation and is also expected to increase the cost of your next mortgage. You may want to refinance your bad credit mortgage now while it's still cheap to do so. Complete the form on this site to see what's available to you.