Beth Silva

PDX Living and Real Estate

The 5/1 ARM is Back. Gasp. Horror. February 15, 2011

Filed under: buying,financing,first time buyer,interest rates,mortgage — bethsilva @ 12:09 pm

I am of the generation that saw the housing bubble and mortgage crisis  from the outside, and when I bought my first home I said NEVER to an adjustable rate mortgage. My fear was always that I would stay in a house longer than 5 years, either because I loved it and didn’t want to sell, or because the market wouldn’t support the sales price that I would want. Either way, my housing nightmare is that I would have an ARM, go past 5 years, and the rate would skyrocket, and I would loose the house because I couldn’t afford the payments. I’ve seen it happen, and therefore I would never get an ARM, and would never recommend my clients get one unless there was absolutely not question about them selling before 5 years. If they had a 2 year work contract, or were in a 3 year graduate program, those situations would make is a viable option. Other wise, stay away from the dreaded ARM! CNN Money disagrees. Below is the article that got me started on that rant. Do you agree with me, the sensible home owner and Realtor, or CNN?

“NEW YORK (CNNMoney) — Adjustable rate mortgages are back! After accounting for nearly 70% of all mortgages issued during the boom, 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.  “Even under a worst case scenario, you’re better off with an ARM if you’re planning to live in the house for less than seven or eight years,” said Steve Habetz, a loan officer with Darien Rowayton Bank in Connecticut.  And, the reset will, most likely, be lower than to 8.5%. The amount the rate can increase is typically calculated by adding a margin of 2.75 points to an index, usually the rate of a one-year T-bill, explained mortgage broker Alan Rosenbaum, founder of GuardHill Financial. And most loans have a maximum amount they can rise per year and a cap on how high the rate can go. Still, many homebuyers want no part of ARMs. “I had a client recently who told me that they were going to move in four or five years,” said Habetz. “I suggested an ARM. They insisted on a fixed rate. It made no sense but that’s what they wanted.” Taking out a reverse mortgage 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.”

Source: By Les Christie, staff writerFebruary 14, 2011: 5:19 AM ET


2 Responses to “The 5/1 ARM is Back. Gasp. Horror.”

  1. […] This post was mentioned on Twitter by Beth Silva, Beth Silva. Beth Silva said: run and cower home buyers: the ARM is back! […]

  2. Beth, this is a great topic. There are a lot of misconceptions about ARMs, and the only cure for that is more discussion!

    First of all, ARMs are the norm for most of the rest of the world. Americans are kind of unique in demanding that a rate be fixed for 30 years, immune from any market forces. The adjustable feature of the ARM acts to reassure the investor against future losses. This can serve to keep rates low NATURALLY, as opposed to government buying up MBS and other non-market driven policies to keep rates, and hence money, artificially cheap.

    I would never recommend that anyone get a mortgage they don’t feel comfortable with, but people need to realize something: ARMs can be just fine and don’t need to equal immediate default. There are caps on how much the rate can adjust. And the rate can also adjust downward. In fact, I have a friend whose rate is going to decrease when the loan adjusts. This is because of the financial index that her rate is tied to.

    If people don’t feel comfortable with an adjustable rate, they should go for the fixed rate. However, they should make that decision based on all of the available information. I think that all too often, people are not given all of the facts they need to make an informed choice.

    Thanks for bringing up a great subject Beth!

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