The seller’s market caused problems in several ways. Because housing prices were rising so fast, buyers did not have time to accumulate sufficient down payments, so mortgage lenders began offering creative financing plans. The most popular being the adjustable rate mortgage (ARM), which allowed a buyer to purchase a home with a small or no down payment and to have low mortgage payments for the first few years of the mortgage. At the end of those first few years, the mortgage payments would rise significantly, which is where problems started. Many buyers found themselves with mortgage payments that had increased significantly when the ARM passed the first couple of years. The buyers then needed to refinance homes at a lower rate. As long as housing prices continued to rise, refinancing was easy. However, in 2005, when housing prices leveled off or even dropped, these buyers found themselves in a position where the amount of money owed on the original ARM was more than the house was now worth and refinancing became close to impossible. Part of the inability to refinance was due to lenders making loans to unqualified borrowers.
Other problems happened with another creative mortgage product called the 100% mortgage, which allowed home ownership without any down payment. These mortgages would be written for the entire price of the home, a price that more than likely was overinflated because it was a buyer’s market. Most 100% mortgages were the adjustable rate type, and when the payments started to dramatically increase, not only did the homeowner have the problem of trying to refinance, but that problem was compounded because in the early years of the mortgage the monthly mortgage payment was almost totally applied toward the interest on the loan and not the principal. This meant that homeowners had little or no actual equity in the property when they attempted to refinance. Without any equity in the property, homeowners needed to refinance the total amount of the original 100% mortgage, an amount that was the overinflated sales price of the home.
Other problems, such as an increase in mortgage fraud and predatory lending, also resulted from the overheated buyer’s market. We will discuss these in depth in later chapters.