(3/23/2011) - When the mortgage meltdown submerged housing and took the
economy with it, adjustable rate mortgages' (ARMs) penchant for skyrocketing
in cost made them the bane of home owners' existence.
Now much less toxic, but still risky for some borrowers, they are making
a small comeback.
ARMs
once accounted for 60 to 70 percent of all mortgages in some product
categories, but the share of ARMs crashed to below 3 percent by 2009,
according to a Federal Bank of New York report.
Today, however, ARMs comprise from 5 to 7 percent in some mortgage
product categories, according to numbers from Freddie Mac and the Mortgage
Bankers Association.
Bank of America recently reported to the New York Times ARMs now account for 10 percent of all
its home loans.
The draw of ARMs is that they come with a rate that's initially lower
than fixed rate mortgages (FRMS).
The average fixed interest rate on conforming 30-year mortgages came in
at 4.99 percent the week ending March 22, according to the weekly Erate Interest Rate Update.
Compare that to the 3.21 percent rate for 5/1 ARMs, loans that remain the same for five years and
then change each year after the fifth year. Some 5/1 ARMs were as low as
2.65 percent during the period.
ARMs come with a starting rate for a given period. The rate remains the
same, typically, from six months or one year to 10 years. After the initial
period, the rate changes, typically each year. A "5/1" ARM, for example, is
fixed for five years and then resets each year thereafter.
How much the rate changes depends upon the "index," which can rise and
fall; "margins," which, when attached to the index, add up to your current
interest rate; and maximums or "caps" that limit the size of the rate
increase during each period and how high the rate can go during the life of
the loan. "Floors" also limit how low a rate can go.
Because the margin is set with the terms of the loan, the interest rate
is at the mercy of the index.
ARMs failed for many borrowers because they came with features that
proved too risky for some home owners. The idea of ARMs is they allow you to
get into a mortgage for less than you'd normally pay, but months or years
down the road, your increasing income would allow you to keep up with the
adjustments to higher rates.
But both lenders and borrowers cheated, biting off more than they could
chew.
Among the most notorious ARMs, was the "option ARM" that allowed borrowers the option to
pay less than the monthly interest. That was fine as long as values
appreciated, but when values plummeted, option ARMs left home buyers in
negative amortization limbo, a position where the mortgage balance rose,
while the home value sank, creating an "underwater" situation many home
owners face today. An "underwater" mortgage is one that is larger than the
home value.
Other ARMs came with short teaser rates that adjusted
every six months, typically up, even as home values were falling and
chipping away at equity. Even long term hybrid ARMs 3/1s, 5/1s, 7/1s and the
like came with adjustments that tripled some mortgage payments at the
original adjustment time, depending upon when the loan originated.
This time around, lenders are rolling out more conservative ARM products
they claim to be "prime" loan products without "teaser" rates and option pay
terms.
Most in demand are the 5/1 and 7/1 hybrids that begin around 3 percent
and stay put for five or seven years, giving borrowers time to prepare for
any adjustment, five to seven years down the road.
