The Comeback of Adjustable Rate Mortgages
Adjustable rate mortgages (ARMs) help in contributing to the financial crisis and were in demand during the housing boom. With the mortgage rates rising this year, ARMs are in demand again, especially by the people who do not intend to stay home for long, like the military families. They are also gaining immense popularity by the people – like freelance employees – who have significant but irregular income.
ARMs are on the quickest rise in those areas of the US that are higher-priced contrasting their use during the housing bubble, when the lenders had flooded working-class neighbors with unsafe ARM products.
Several buyers today face a dilemma of choosing between a long-term traditionally low-interest rate and a rate that’s even lower for immediate savings in the short-term. For example, a homeowner with a loan of $150,000 could save over $7,500 over 5 years by not choosing a fixed-rate loan and choosing an ARM instead. This does come with risks as the loan borrower has to take a chance that mortgage rates will be significantly higher when the interest rates do reset, potentially ruining all savings and thus leading to even defaulting.
The ARMs today are less toxic than those offered during the time when the markets were high. Sub-prime ARMs, along with most option ARMs – that allow buyers to pick between paying interest only or paying full sum with principal and interest – have vanished. Industry experts suggest that the ARM share is expected to cross 12% this year, with interest rates expected to increase to around 5%. They also state that most home-buyers have preferred to go for fixed-rate mortgages in the past couple of years because they had low interest rates and the monthly payment and interest rate was certain.
However, as against industry experts, economists do not believe that the increase in ARM share is any cause for alarm. They mention that the average share of these ARM loans was 24% in the year 1985, and thus the market share still remains at a conventional low. Based on popularity of ARM on the market, the 5/1 ARM ranks first, followed by 3/1, 7/1, and 10/1 loan. Thus at 3.15% interest rate, a loan borrower will need to pay off 11% of the outstanding balance post 5 years, 15% post 7 years, and 23% post 10 years. This distribution provides an equity buffer which protects loan lenders in case the borrowers begin to default.
ARMs are now not used to attract borrowers with low teaser rates that reset to a level that is beyond the borrower’s means. This is because the CFPB’s ability-to-repay rule no longer allows the mortgages to be written. Loan lenders have to now consider the highest interest rate — and not the teaser rate — to assure that a borrower can afford the loan.