Adjustable Mortgage Rate
Adjustable Rate Mortgage Loans
Adjustable Rate Mortgages Carry Substantial Risk
by G. Mundy
There are some exotic adjustable rate mortgage loans (ARMs) available these days that are capable of jumping fifty to eighty percent when the day comes for adjustment. Interest only adjustable mortgage rates can be frightening when they are projected into the future, and option ARMs are worse. But setting those recent creations for a moment, consider what a standard adjustable rate mortgage issued five years ago can do to a two-income family of average means.
If a $250,000 adjustable rate mortgage loan resets from 4 percent to 6 percent, the monthly payment for principal and interest jump from $1,094 to $1,499. That's like dropping a new car payment into the budget. A family with active kids and a budget below $80,000 a year may well be challenged by an increase like that.
So-called subprime borrowers are going to face a bigger challenge, because their less-than-perfect credit histories meant they already were paying higher interest rates, and they're less protected from rate increases than prime borrowers, whose interest rates are capped at 2 percentage points a year. Subprime adjustable rate mortgage loans may go up as much as 5 percentage points in a year.
Another group at particular risk for payment shock are borrowers who chose ARMs around 2002 and 2003, when interest rates were at rock bottom, and are soon to experience their first rate adjustment. Twenty five percent of all mortgages in this country today are adjustable rate mortgage loans. Thirty seven percent of all new mortgages being issued today are ARMs; many of those are interest only adjustable loans.
About one-quarter of the total pool of first mortgage loans in the U.S., or about $2 trillion, carry interest rates set to adjust in the next three to four years, according to an analysis by research firm LoanPerformance. With what has now officially been declared a flat housing market, people paying interest only adjustable loan rates may find themselves owning a home in which they hold little or no equity. That possibility is going to eliminate the option of refinancing out of an extreme jump in the mortgage payment.
Most experts say subprime delinquencies will probably increase about 25 percent in the next year as the impact of rising interest rates sets in. According to Realty Trac Inc. foreclosures are up seventy two percent in the first three months of 2006. While these may not yet be subprime borrowers, those interest only adjustable loan rates are going to have a much higher impact than the current crop of standard ARMs.
Over the last couple of years, ten million people who could not afford a down payment and who had checkered credit ratings bought a home. It's hard to believe that these statistics aren't going to culminate in a real problem with adjustable rate mortgage loans over the next few years. It's an issue worth studying if you are considering getting into the housing market in the near future.
About the Author
G. Mundy is a freelance writer specializing in bad credit mortgages and finances. For more information, please visit Mortgage Lenders Plus.com
An ARM That Only Adjusts Down? by G. Mundy
Some marketers just never sleep. A new concept called a "ratchet mortgage" is being proposed that would provide for interest rates reductions when the rate index changes, but would be designed so that interest rates would never adjust up. Apparently this was attempted in the '90s with mixed results, since investors were shy about buying portfolios of mortgages that have only reductions in interest incorporated into their adjustable rates.
Now, a couple of financial professionals are set to give it another try. Bert Ely and Andrew Kalotay - who are based in Washington, D.C., and New York, respectively - have been pitching their vision for the ratchet mortgage to industry groups in recent weeks.
As you might expect, any consumer who is asked about the concept says "Sure, I want one of those." So Mr. Ely says in an interview that "The market demand will be there, but there are a lot of mortgage-initiation issues that have to be dealt with. Lenders are not going to offer this unless it's a profitable product."
What the two financial chess players have devised is a system that makes the mortgage concept work because the mortgage interest rate is tied to the interest rate on the bonds that would finance them. They are proposing a system that ties both the mortgage and the fund on which it is drawn to the 10 year Treasury note yield. There would be a fixed rate spread between the two - half a percentage point perhaps - that maintains a steady profit margin even as the rates drop. They have gone so far as to apply for a patent on the system.
"With the previous automatic rate-cut mortgages, the problem was that they never figured out how to finance the mortgages," Ely said. "Ours is built upon the rate-reducing future of the mortgage and the instrument that funds the mortgage. As the interest rate clicks down on the mortgage, the interest will also click down on the funding instrument."
Ely noted that "The amount of refinance activity goes up when rates fall and goes down when rates rise," he said. "What the ratchet mortgage does is mimic that, in a more efficient fashion: When rates start going down, it would go down. And when rates start going up, it would stay the same - which is the same as people saying, 'I don't think I'll refinance now because rates are high.'
If the concept flies, however, it will mean a reduction in the substantial mortgage refinancing activity that goes on now due to the number of ARMs in circulation. And that would not serve the mortgage industry well. Ely dismisses this concern by noting that all innovations affect the status quo. "It's great for homeowners and it's great for the economy...but a lot of people who profit from the current system's inefficiency don't get too excited about efficiency."
A skeptic in the banking industry noted that similar concepts have been tried before but now adopted by "the marketplace." By this he meant the lenders and brokers who originate mortgages. A ratchet mortgage is designed to be a permanent mortgage, one that doesn't grow prohibitively expensive when the rate adjusts. That means the average mortgage broker is not going to see repeat business from the person that signs for a 3/1 ARM in his office. The self perpetuating nature of the mortgages in circulation today may preclude the industry from adopting a real consumer innovation.
About the Author
G. Mundy is a freelance writer for Mortgage Lenders Plus.com, a lender directory for bad credit mortgage & refinance. For more information, please visit us online.
