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The Honolulu Advertiser
Posted on: Monday, January 2, 2006

'Exotic' mortgages on the rise in Hawai'i

 •  Hawai'i housing market likely to remain strong

By Greg Wiles
Advertiser Staff Writer

Pro surfer and restaurateur Jairus Cannon stands in front of his Wahiawa business. He's using alternative financing to buy a home in Hale'iwa.

JEFF WIDENER | The Honolulu Advertiser

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Jairus Cannon, a 31-year old restaurateur and professional surfer, doesn't have a down payment to get a home on O'ahu's pricey North Shore, but that's not stopping him from buying.

Cannon, who last year opened up Maui Mike's Fire-Roasted Chicken in Wahiawa, is lining up financing to cover 100 percent of the purchase price. Once he closes on a house, he'll only make interest payments on his loan for the first several years.

"It's the time to do it," said Cannon, who has watched home prices surge near his Hale'iwa rental. "I just see all the Mainland people that want to have something in paradise and are all looking on the North Shore."

Cannon is one of a growing number of prospective Hawai'i homeowners who are turning to so-called exotic financing to get into the state's real estate market. While these new loan products can bring down monthly payments, they can also carry greater risks.

Adjustable-rate loans, when coupled with an interest-only feature, can lower a borrower's payments during the first few years of the mortgage. Thereafter the borrower faces much larger payments as he is forced to begin paying off the loan principal also.

Problems could develop for borrowers if they can't increase their income to meet the higher payments and aren't able to sell or refinance the property if prices have fallen.

It's clear why home buyers are attracted to the new mortgage types. Higher prices the median price of a single-family home was $640,500 in November and slightly higher mortgage rates have made it impossible for many families to buy a home using a standard 30-year fixed-rate loan with a 20 percent down payment.

Traditional financing leaves you with a monthly payment of $3,347 on a median-priced home at current interest rates, according to Mortgage Plus, a Fort Street Mall mortgage broker. The monthly payment grew by $846 in the past year alone.

Last year the median price was $490,000 and required a monthly payment of only $2,501.

The average Honolulu home was the third-most costly nationwide during the third quarter, tying San Diego and trailing San Francisco and parts of Orange County, Calif., according to the National Association of Realtors.

At $640,500, the median home price has more than doubled in the past four years.

"These are numbers that our parents would have said 'Are you out of your mind?' " said Claude Phillips, president of Mortgage Plus.

The result is more and more borrowers looking for flexible loans.

"What used to be exotic five years ago are now considered common," said Robert Boon, chief operating officer for lender First Magnus Financial Corp.'s Pacific division. That includes 80-10-10 mortgages where people put 10 percent down, and finance 80 percent of the purchase price with a first mortgage. The remaining 10 percent would be paid for with a second mortgage.

"From a year ago all these products have grown in usage," Boon said.

The nontraditional mortgages include 40-year loans and interest-only mortgages that can feature either fixed or adjustable interest rates. They generally carry higher interest rates than conventional loans.

There are even Hawai'i buyers taking out so-called "option ARMs," or mortgages under which the borrower can choose to make payments that are less than the interest that's owed. In that instance, the amount of loan increases, or goes into what's called negative amortization.

The option ARM isn't widely available locally Bank of Hawaii, one of the state's top lenders, doesn't offer it. The mortgage also has drawn some criticism, including comments from outgoing Federal Reserve Chairman Alan Greenspan.

In June, Greenspan told Congress that interest-only and some of the more exotic adjustable-rate mortgages may be pushing up home prices in some markets to unsustainable levels. He said they possibly posed a threat to mortgage lenders if the economy soured and borrowers had trouble making payments.

"To be sure, these financing vehicles have their appropriate uses," Greenspan testified. "But some households may be employing these instruments to purchase homes that would otherwise be unaffordable and consequently their use could be adding pressures in the housing market."

The attractiveness of some of the new mortgages is unmistakable when it comes to lowering payments, though. Mortgage Plus' calculations show monthly payments for a 6.125 percent interest-only loan on a $640,500 house with 20 percent down are $2,890.

That's $457 a month less than what they'd pay with a traditional mortgage in the example above.

Moreover, the amount of annual income required to qualify for the loan would be less.

To get a mortgage with monthly payments of $3,347 a month, homeowners would need to make more than $80,000 a year if lenders had very liberal income requirements and allowed payments amounting to 50 percent of gross income.

For a $2,890 payment they would only need to make a little more than $69,000, assuming the same conditions. That's close to O'ahu's annual median household income of $67,750 this year as estimated by University of Hawai'i-Manoa economist Carl Bonham.

"We're seeing more exotic mortgages," said David Quandt, regional director for Charter Funding of Hawaii. "For people that are house hungry they're willing to take that risk to get that home."

Reach Greg Wiles at gwiles@honoluluadvertiser.com.