Are Adjustable rate mortgages back from the dead?
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Arnould Swaniger Adjustable rate mortgages are back. After accounting for nearly 70% of all mortgages issued during the boom, adjustable rate mortgages (ARMs) vanished during the bust, totaling just 3% of the market in 2009. Now they make up 5% of all mortgages issued, and Freddie Mac predicts 10% by December. Behind the comeback is a simple fact: ARMs are a great bargain right now. The most common ARM loan currently has a rate of 3.5% compared to 5% for a 30-year fixed-rate mortgage. "For anyone with a high likelihood of moving soon, the 5/1 is a great product," said
Michael Fratantoni, vice president of research and economics for the Mortgage Bankers Association. "It's a well understood product too; there's not a lot of danger with it." So why isn't everyone grabbing an ARM? Well, because fixed-rate mortgages are seen as safer because they carry the same rate over life of the loan. Borrowers always know what their payment will be. But with ARMs, interest rates change over time.
For example, the 5/1 ARM -- the most common loan -- has the 3.5% introductory rate for the first five years. After that, the rate adjusts annually. That sounds kind of dangerous, but look deeper. On a $200,000 mortgage, the monthly ARM payment at 3.5% would be $898 compared with $1,074 for a 30-year, fixed-rate loan at 5%. That's a $10,560 difference after five years, when the ARM would adjust. At that point the ARM rate could jump to a worst-case scenario 8.5% and the monthly payment to $1,538. It would still take more than 22 months of the higher ARM payments to offset the first five years of savings. Many buyers remember the so-called toxic or exploding ARMs and how their defaults triggered the mortgage meltdown, helped sink the housing market and usher in the Great Recession. These loans failed for a couple of reasons. Many were issued to people who lacked the income to pay once the initial years of low fixed rates ended and the interest rate reset higher. Too, the caliber of
borrowers was very low. The 5/1 is an entirely different animal, experts says.
Unlike the toxic ARMs, these products are issued to borrowers with high credit scores, making substantial down payments and with assets, debt and income carefully underwritten before approval. Rosenbaum said he's always featured the 5/1 ARM as the product of choice unless the clients tell him they're planning to live in the home for 15 or 20 years. For people planning to stay for less time, "It's paying for insurance they don't need," he said.
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