Are Adjustable Rate Mortgages (ARMs) still considered too risky? (1 Viewer)

[Navin Johnson]

It wasn't a conforming ARM then. 

They rarely were.  Hard to find anything that wasn't Jumbo in the bay Area early 2000's

 

[Dickies]

Her: "I'm not saying no to you, but

My wife's favorite phrase, and if I have learned one thing in my marriage it's that this means she is actually saying no.

 

[El Floppo]

The answer to the question of ARMs is.... it depends. 

First, the risk, the only real risk to ARMs is potential for interest rate risk going higher. There is more assumption of risk to some who don't really understand personal finance and/or mortgages and remember 2008 and how evil ARMs are (more on that later). The starting point to understand your exposure to risk on an ARM to figure out if it is right for you or not is your intentions for the property, the product itself and expectations of rates in the future. 

1) What are you intention for the property? 
The longer you expect to have the property or the loan is the main driver to figuring out risk. The reality is that the vast majority of mortgage loans do not live past 7 years in term. This is due to people selling the homes, refinancing the loan or even paying off the loan. If you plan on selling in a shorter time span then the more an ARM makes sense. The longer you expect to have the loan, the less it makes sense for you. 

2) What product is right? 
ARMs use to be 3/1, 5/1, 7/1, 10/1 etc... the first number being how long the initial rate was locked in for. 3 being 3 years or 5 being 5 years etc. The 1 behind it being that after that initial period, the rate would adjust annually afterwards. The mortgage would have an index (it use to be most would have LIBOR at the index but after some scandals with LIBOR it has been removed) and a margin. The margin is fixed and the index is what goes up or down. When the index goes up on your change period, then your rate goes up. However, if the index goes down, your rate goes down as well. As mentioned, LIBOR has been replaced with SOFR and now the adjustments are every six months after the initial period, so the ARMs are 3/6, 5/6, 7/6 and 10/6 as the most common. It is also important to know the caps on these adjustments. There are 4 types of caps: 1) Initial Cap- the most the rate can change on the first adjustments 2) Adjustment Cap- the most the rate can change each adjustment period 3) Lifetime Cap- the most the rate can change over the life of the loan and 4) Payment Cap- the most the payment can change each adjustment. These help to limit your risk and you would want to know the specifics of these. 

3) What will rates do in the future? 
This is the driving force right now. Rates have gone up over the last few months but there is a strong expectation that rates will come back down in the not too distant future. I, along with others who watch these things, believe that in a year or two, rates will be dramatically down from where they are now. This means doing an ARM now with a lower rate can be an aggressive way to save money with the expectation of doing a refinance in the not too distant future that would lower your rate and get you into a fixed rate loan. 

As mentioned before, the big reason people have this "OH NO! NOT THAT!!! THEY ARE EVIL!" response to ARMs is due to the 2008 RE meltdown. ARMs really got a bad rap as being the reason for causing the RE meltdown. The reality is that there were numerous things that had much more impact on what lead to the eventual collapse of the RE in 2008 but what ended up as the poster child was Option ARMs. Options ARMs were a product that gave you an "option" on making a payment each month. 1) 30 yr amortized payment 2) 15 yr amortized payment 3) Interest only payment and 4) Minimum payment. The minimum payment being negative amortization. Now, there was nothing wrong with the product itself. It was ideal for a consumer that was had a commission based or otherwise highly adjustable income where they could have great months and little or no income other months. This allowed them to be more flexible. The PROBLEMS with the Options ARMs were two things- First, they were sold to many people who didn't understand what they were and not a good fit. Second, the underwriting would qualify them on the lower of payments from the initial rate and that was it. With people who thought, "great, I can make this minimum payment" and not realize it was negative amortization because they were never told or explained and they were not the real fit for the customer and then a big movement on property values in the decline, these people quickly ended up under water on their homes. Option ARMs were kind of the red herring of bank problems for the media which started with IndyMac. IndyMac was a big player with Option ARMs and it's failure along with the long lines in front of the branches of people trying to get their money out is what really kicked off the 2008 meltdown. Once that happened, the media started asking who is next? Well, if IndyMac was known for Option ARMs... who else does them? WaMu! Then that lead to a bank run on WaMu losing about 10% of it's deposit based in about 11 days I believe. Every single bank would fail with that kind of run on deposits. So, WaMu was handed to Chase for pennies on the dollar. The next up after that was Word Savings and then the Feds brokered a deal to sell that for pennies on the dollar to Citi as a way to shore up Citi but Wells Fargo came in with a much more attractive offer and the Feds couldn't force the deal through, so World Savings went to WFC, by that time, the RE meltdown was well underway. Bears had already failed and we all know the rest.

Option ARMS died back in 2008. ARMs are fine, if used correctly. In fact, I have personally advised many clients to do an ARM with the expectation of refinancing or them selling the property in the near future over the years and this current rate environment is a great example of when it makes sense. If I was buying a home right now, it would be with an ARM. However, yes, there is a little more risk. If I am wrong and rates do no retreat then instead of saving money, you may end up spending more money. You need to realize that and move forward or not with that knowledge. 

hell yeah... this was some incredible info that finally made sense of it all for a dumb guy (l'm talking chiefd here). THANK YOU.

some of us may still need pictographs, charts and/or finger puppets (I'm talking... crap- I'm talking about me, ok... OK?!)

 

[Chadstroma]

They rarely were.  Hard to find anything that wasn't Jumbo in the bay Area early 2000's

Back then totally different game. Though they were not conforming (conforming = conventional aka able to be sold on the secondary market to Fannie Mae or Freddie Mac) there were a ton of portfolio loans with good pricing that were being sold in MBS. 

I had conversations with a guy who was a risk analyst in the room for a large bank talking to execs about how they needed to stop doing higher risk loans like Option ARMs (a very common type of IO loan back then) and then in walks all the investment bankers from Bear Stearns, Lehman Bros, Goldman, etc that were demanding these loans. These guys were suppose to be the smartest people in the room and the execs basically said... ok. 

An IO ARM under jumbo limits now likely isn't going to have much of a market to be sold to. I would bet the pricing on it would be just nasty. Jumbo is a different world though still. 

 

[Chadstroma]

hell yeah... this was some incredible info that finally made sense of it all for a dumb guy (l'm talking chiefd here). THANK YOU.

some of us may still need pictographs, charts and/or finger puppets (I'm talking... crap- I'm talking about me, ok... OK?!)

Don't tempt me to bust out the Financial Crisis 2008 Puppets!

 

[Chadstroma]

The answer to the question of ARMs is.... it depends. 

First, the risk, the only real risk to ARMs is potential for interest rate risk going higher. There is more assumption of risk to some who don't really understand personal finance and/or mortgages and remember 2008 and how evil ARMs are (more on that later). The starting point to understand your exposure to risk on an ARM to figure out if it is right for you or not is your intentions for the property, the product itself and expectations of rates in the future. 

1) What are you intention for the property? 
The longer you expect to have the property or the loan is the main driver to figuring out risk. The reality is that the vast majority of mortgage loans do not live past 7 years in term. This is due to people selling the homes, refinancing the loan or even paying off the loan. If you plan on selling in a shorter time span then the more an ARM makes sense. The longer you expect to have the loan, the less it makes sense for you. 

2) What product is right? 
ARMs use to be 3/1, 5/1, 7/1, 10/1 etc... the first number being how long the initial rate was locked in for. 3 being 3 years or 5 being 5 years etc. The 1 behind it being that after that initial period, the rate would adjust annually afterwards. The mortgage would have an index (it use to be most would have LIBOR at the index but after some scandals with LIBOR it has been removed) and a margin. The margin is fixed and the index is what goes up or down. When the index goes up on your change period, then your rate goes up. However, if the index goes down, your rate goes down as well. As mentioned, LIBOR has been replaced with SOFR and now the adjustments are every six months after the initial period, so the ARMs are 3/6, 5/6, 7/6 and 10/6 as the most common. It is also important to know the caps on these adjustments. There are 4 types of caps: 1) Initial Cap- the most the rate can change on the first adjustments 2) Adjustment Cap- the most the rate can change each adjustment period 3) Lifetime Cap- the most the rate can change over the life of the loan and 4) Payment Cap- the most the payment can change each adjustment. These help to limit your risk and you would want to know the specifics of these. 

3) What will rates do in the future? 
This is the driving force right now. Rates have gone up over the last few months but there is a strong expectation that rates will come back down in the not too distant future. I, along with others who watch these things, believe that in a year or two, rates will be dramatically down from where they are now. This means doing an ARM now with a lower rate can be an aggressive way to save money with the expectation of doing a refinance in the not too distant future that would lower your rate and get you into a fixed rate loan. 

As mentioned before, the big reason people have this "OH NO! NOT THAT!!! THEY ARE EVIL!" response to ARMs is due to the 2008 RE meltdown. ARMs really got a bad rap as being the reason for causing the RE meltdown. The reality is that there were numerous things that had much more impact on what lead to the eventual collapse of the RE in 2008 but what ended up as the poster child was Option ARMs. Options ARMs were a product that gave you an "option" on making a payment each month. 1) 30 yr amortized payment 2) 15 yr amortized payment 3) Interest only payment and 4) Minimum payment. The minimum payment being negative amortization. Now, there was nothing wrong with the product itself. It was ideal for a consumer that was had a commission based or otherwise highly adjustable income where they could have great months and little or no income other months. This allowed them to be more flexible. The PROBLEMS with the Options ARMs were two things- First, they were sold to many people who didn't understand what they were and not a good fit. Second, the underwriting would qualify them on the lower of payments from the initial rate and that was it. With people who thought, "great, I can make this minimum payment" and not realize it was negative amortization because they were never told or explained and they were not the real fit for the customer and then a big movement on property values in the decline, these people quickly ended up under water on their homes. Option ARMs were kind of the red herring of bank problems for the media which started with IndyMac. IndyMac was a big player with Option ARMs and it's failure along with the long lines in front of the branches of people trying to get their money out is what really kicked off the 2008 meltdown. Once that happened, the media started asking who is next? Well, if IndyMac was known for Option ARMs... who else does them? WaMu! Then that lead to a bank run on WaMu losing about 10% of it's deposit based in about 11 days I believe. Every single bank would fail with that kind of run on deposits. So, WaMu was handed to Chase for pennies on the dollar. The next up after that was Word Savings and then the Feds brokered a deal to sell that for pennies on the dollar to Citi as a way to shore up Citi but Wells Fargo came in with a much more attractive offer and the Feds couldn't force the deal through, so World Savings went to WFC, by that time, the RE meltdown was well underway. Bears had already failed and we all know the rest.

Option ARMS died back in 2008. ARMs are fine, if used correctly. In fact, I have personally advised many clients to do an ARM with the expectation of refinancing or them selling the property in the near future over the years and this current rate environment is a great example of when it makes sense. If I was buying a home right now, it would be with an ARM. However, yes, there is a little more risk. If I am wrong and rates do no retreat then instead of saving money, you may end up spending more money. You need to realize that and move forward or not with that knowledge. 

One self correction... 

World Savings was bought by Wachovia before the poo hit the fan (great timing by the World Savings execs, horrible decision by Wachovia which was otherwise a well run bank). Wachovia was later offered to Citi to prop it up and Wells Fargo came in and stole it for more (though it was still a steal). 

 

[-OZ-]

Basically.  You factor the break even cost against a future refi.   Your black swan event I suppose is rates going to like 12% 

Would you have the savings to pay off the house in 7 years worst case scenario? 

No. 

You’re a FBG. A private practice attorney FBG. Of course you’ll have the money to pay it off. The question will be what would you sacrifice to do so. The jet or the yacht. 
glad to see you went with your wife’s opinion really, Most of us would have done the same. 
I’m thrilled to have locked in our 30. 

 

[Zow]

You’re a FBG. A private practice attorney FBG. Of course you’ll have the money to pay it off. The question will be what would you sacrifice to do so. The jet or the yacht. 
glad to see you went with your wife’s opinion really, Most of us would have done the same. 
I’m thrilled to have locked in our 30. 

I have clients that provide the bold. 

Kids are expensive, man. 

 

[-OZ-]

Kids are expensive, man. 

 go on…

 

[Zow]

So the house just appraised at $216k over what we're paying.

 

[Gally]

So the house just appraised at $216k over what we're paying.

SELL! SELL! SELL!

 

[Chadstroma]

So the house just appraised at $216k over what we're paying.

wow

 

[Zow]

wow

Yep. Couldn't believe it myself.