Nov222013
Lender propaganda campaign extolls adjustable-rate mortgages
What is the price for your soul? What would you have to be paid to advocate for something you knew was harmful? 
Would you feel comfortable creating ads for cigarette companies? Would you work for a lender making subprime loans or HELOCs? How dangerous does a product have to be before you couldn’t participate in its manufacture or distribution in good conscience?
Even writers and reporters face these dilemmas, particularly those who offer opinions to influence people’s decisions and behaviors. Because real estate agents historically spent millions on print advertizing, it’s rare to read negative stories about realtors or the health of the real estate market. With so much paid propaganda, they exert a subtle yet powerful control over the entire mainstream media. Many freelance writers publish puff pieces to give realtor propaganda the veneer of credibility it lacks otherwise. It isn’t only realtors who sponsor propagandist attempts to educate the general public with bad information and advice.
Today’s featured article is another attempt by the lending industry to convince people to use adjustable-rate financing. That form of financing provides a short-term improvement in rate while sacrificing long-term payment stability. Only the most foolish and short-sighted consumers benefit from these loans, but banks love them because it pushes interest rate risk on the consumer who doesn’t understand what that risk entails.
Why Flexible-Rate Mortgages Make Sense
Conventional wisdom says go for a fixed-rate loan. For many people, that isn’t all that wise.
By SIMON CONSTABLE — Updated Nov. 10, 2013 4:19 p.m. ET
If you’re buying a home anytime soon, here’s some contrarian advice: Don’t take out a fixed-rate mortgage. If you do, you’re likely to pay more than you need to.
This is perhaps the worst and most misleading analysis I’ve ever seen. This embarrasses the Wall Street Journal to publish such a thing. They calculated the savings on the spread of the fixed rate mortgage versus the adjustable rate mortgage assuming the borrower wouldn’t refinance into a lower rate. Most fixed-rate borrowers refinance if rates drop, and nobody refinances their fixed-rate mortgage when rates go up. That’s the whole point in using a fixed-rate mortgage. Fixed-rate mortgage payments never increase unless the borrower increases the size of their mortgage.
Instead, it often makes more sense to choose a floating-rate note, also known as an adjustable-rate mortgage. Even on a small mortgage, over time you’ll save thousands of dollars. If you use the extra cash to pay down the loan, you’ll save even more.
Which, of course, nobody will. Like Option ARM teaser rate payments, 85% of borrowers only make the minimum payment all the time.
Such loans come in and out of fashion for a couple of reasons, says Frank Nothaft, chief economist at Freddie Mac. When rates on fixed loans are perceived to be low, borrowers tend to shun ARMs. When the difference between fixed and floating rates is small, again people tend to shun ARMs. Floating-rate notes are considered riskier than fixed-rate mortgages because the monthly payment can jump higher.
And almost certainly will move higher considering we are only now coming off record lows.
A so-called one-year ARM typically will reset each year based on fluctuations in the interest rate on the one-year Treasury security or the interbank cost of borrowing known as Libor. Other common ARMs reset each year after an initial fixed period of three, five or seven years.
A bomb with a long fuse is still a bomb.
Fixed-rate mortgages do make sense for some people. For instance, if your budget is so tight that even a small increase in your monthly payment would break the bank, a fixed-rate mortgage makes sense. A fixed rate would also make sense if you will keep your new home for a long time, like 30 years.
But for many people, ARMs come out ahead. Those people need to close their ears to the deafening sound of the ARM naysayers, like one financial planner I heard from: “You have got to be kidding. I guess a bad idea never dies. Don’t Americans ever learn?” I’ve withheld the name because I don’t want to embarrass him.
Give me his name. I want to promote him on this blog. He won’t be embarrassed; he will be embraced. The author of this article should hide his head in shame.
It’s true: Many people have been burned by ARMs. But as long as you are smart about it—more on that later—that financial adviser is wrong.
I watched a performer juggle burning torches. Playing with fire can be profitable if you’re smart about it… I guess.
The main reason an adjustable rate will be cheaper is this: You almost certainly won’t be in your new house or apartment for the next 30 years, the typical life of a fixed-rate mortgage. Most people move every eight to 10 years, says Scott Buchta, head of fixed-income strategy at New York-based brokerage firm Brean Capital LLC. And even if you do stay longer than that, your mortgage won’t survive 30 years if you refinance at some point.
Borrowers will refinance less in the future. People simply don’t refinance when interest rates are rising because the long-term cost of money outweighs the short-term benefit. While people may not stay in the same house and pay the same mortgage for 30 years, it’s certainly preferable to have a fixed housing payment for as long as they stay.
That’s important because the main reason the rate on a 30-year, fixed mortgage is higher than floating rates is that the lender assumes you will take the full 30 years to pay it back. That puts the lender at risk of losing money on the loan if borrowing costs go up during that term. So the lender charges you more.
The premium is very small. In fact, many critics decry the 30-year fixed-rate mortgage claiming it would not exist outside of government guarantee. However, the FHA ran a self-sustaining program insuring fixed rate mortgages for more than 60 years without difficulty. If not for its use as the lender of last resort while the housing bubble collapsed, it wouldn’t need a bailout today. That strongly suggests that under normal circumstances the risk in 30-year fixed-rate mortgages is priced properly.
For that higher interest rate, you get a form of insurance: the security of knowing what your payments will be for the life of the loan. You can sleep better at night, knowing that if interest rates shoot higher, it won’t hurt you.
That’s exactly why everyone should use this form of financing exclusively.
But if you close out the loan in, say, 10 years—by moving or refinancing—you’ve paid too much for that insurance, because you were paying as though you needed 30 years of it.
Complete and utter bullshit.
Here’s an example of how much that can cost you. If you took out a 30-year mortgage in January 2003 the average fixed rate was 5.92%, according to Freddie Mac. Ten years of interest and principal payments on a $200,000 mortgage would have cost you $142,660. But if you went with a one-year ARM, which kicked off at 3.99%, according to Freddie Mac, after resetting each year the total cost would have been $119,181. That’s a savings of $23,479.
And if the borrower were stupid enough to keep a 5.92% fixed rate mortgage despite the numerous opportunities to refinance at much lower fixed rates, then their own foolish inattention cost them $23,479. It wasn’t the loan product that created that problem.
Really… Why do I need to point this out? Surely the guy writing this article sees how stupid and misleading his example is. This is what convinces me he must have sold a piece of his soul to write this garbage. I hope he was paid well. His real cost is hidden.
I can’t go on with this article. It annoys me too much. Read it for yourself. It doesn’t get any better.
Don’t use an adjustable-rate mortgage
Over the last 30 years of steadily declining interest rates, buying a house with an ARM didn’t create any long-term problems. Many buyers just waited for rates to go back down and refinanced into a fixed-rate mortgage. Some kept their ARM because the steadily dropping rates kept making their payment lower. Almost nobody recognized any risk to using an ARM because after such a long period of declining rates, everyone assumed rates would just fall forever — or for at least as long as they owned the property.
The problem with ARMs is only evident in a rising interest rate environment, and as I have discussed in numerous posts, we are at the bottom of the interest rate cycle, and rates are likely to steadily rise from here — perhaps for a very long time. Peak to trough on the interest rate cycle is usually 20 to 30 years.
Adjustable-rate mortgages have a contract interest rate that gets adjusted periodically based on the movement in some benchmark, often the federal funds rate or LIBOR. The promissory note usually has a contractual limit as to how high the rate can go, but the borrower is only qualified based on the initial contract rate. The assumption is that the borrower will see increasing wages, and if and when the rate goes up, they will be able to afford the higher payment.
This assumption carries hidden dangers. First, not everyone sees pay raises over time. Borrowers in their prime earning years may be maxed-out on the income they can be reasonably expected to garner. Second, even if the borrower does get raises, these raises may not keep up with the increasing cost of the mortgage. In either case, the borrower is either drained of all the benefit of their increasing pay, or they fail to keep up with the payments, go into delinquency, and end up as a foreclosure.
Perhaps the risk of ARMS will not be so great even if rates rise. Banks have become accustomed to giving loan modifications when borrowers can’t afford payments, and since loan modifications are the new borrower entitlement, people who foolishly take out ARMs at the bottom of the interest rate cycle will get bailed out by banks looking to avoid foreclosure. However, if house prices keep rising, and if the borrowers have any equity, the bank may not wish to extend a loan modification and may pursue a foreclosure instead.
Banks prefer borrowers to take out ARMs, particularly for the loans they keep on their balance sheets. ARMs pass interest rate risk onto the borrower. As long as the borrowers can afford the higher payments, and as long as the borrowers have equity that would allow the bank to foreclose, the bank really doesn’t care if the ARM becomes a hardship to the borrower; after all, it makes the bank more money.
Hopefully, borrowers are wise enough to take care of themselves. As you can see from the propaganda lenders are polluting the mainstream media with, they are taking care of themselves.
[idx-listing mlsnumber=”PW13230912″]
1311 North FRENCH St Santa Ana, CA 92701
$4,195,000 …….. Asking Price
$2,200,000 ………. Purchase Price
8/21/2002 ………. Purchase Date
$1,995,000 ………. Gross Gain (Loss)
($335,600) ………… Commissions and Costs at 8%
============================================
$1,659,400 ………. Net Gain (Loss)
============================================
90.7% ………. Gross Percent Change
75.4% ………. Net Percent Change
5.7% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$4,195,000 …….. Asking Price
$839,000 ………… 20% Down Conventional
4.89% …………. Mortgage Interest Rate
30 ……………… Number of Years
$3,356,000 …….. Mortgage
$863,242 ………. Income Requirement
$17,791 ………… Monthly Mortgage Payment
$3,636 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$874 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
============================================
$22,300 ………. Monthly Cash Outlays
($3,000) ………. Tax Savings
($4,115) ………. Principal Amortization
$1,580 ………….. Opportunity Cost of Down Payment
$1,069 ………….. Maintenance and Replacement Reserves
============================================
$17,834 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$43,450 ………… Furnishing and Move-In Costs at 1% + $1,500
$43,450 ………… Closing Costs at 1% + $1,500
$33,560 ………… Interest Points at 1%
$839,000 ………… Down Payment
============================================
$959,460 ………. Total Cash Costs
$273,300 ………. Emergency Cash Reserves
============================================
$1,232,760 ………. Total Savings Needed
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Foreclosure Inventory Plunges Nearly 30%, Can Kicking works
The nation’s foreclosure inventory has contracted for 18 consecutive months and is now at its lowest point since the end of 2008, totaling 1.28 million loans, or just 2.54 percent of today’s active mortgages, according to Lender Processing Services (LPS).
The company’s latest report assessing loan-level data on the performance of mortgage assets through the end of October shows the industry’s foreclosure inventory rate is down 29.61 percent from last year. Through the first 10 months of 2013, the foreclosure inventory rate has plummeted 26 percent.
Delinquencies dropped 2.8 percent month-over-month in October to come in at a rate of 6.28 percent. LPS says while that’s not as low as the delinquency rates recorded
earlier this year—in August the rate was 6.20 percent and in May it settled in at 6.08 percent—it’s still headed in the right direction. Compared to last year, the rate of mortgages 30-plus days delinquent is down 10.69 percent.
Nationwide, there are 3,152,000 properties with mortgages 30 or more days past due; 1,283,000 of those are 90 or more days delinquent but not in foreclosure. Add to that the 1,276,000 loans that are part of the pre-sale foreclosure inventory, and there are 4,427,000 non-current home mortgages in the United States, by LPS’ assessment.
4,427,000 non-current home mortgages in the United States
The nation’s foreclosure inventory has contracted for 18 consecutive months and is now at its lowest point since the end of 2008, totaling 1.28 million loans, or just 2.54 percent of today’s active mortgages, according to Lender Processing Services (LPS).
The company’s latest report assessing loan-level data on the performance of mortgage assets through the end of October shows the industry’s foreclosure inventory rate is down 29.61 percent from last year. Through the first 10 months of 2013, the foreclosure inventory rate has plummeted 26 percent.
Delinquencies dropped 2.8 percent month-over-month in October to come in at a rate of 6.28 percent. LPS says while that’s not as low as the delinquency rates recorded
earlier this year—in August the rate was 6.20 percent and in May it settled in at 6.08 percent—it’s still headed in the right direction. Compared to last year, the rate of mortgages 30-plus days delinquent is down 10.69 percent.
Nationwide, there are 3,152,000 properties with mortgages 30 or more days past due; 1,283,000 of those are 90 or more days delinquent but not in foreclosure. Add to that the 1,276,000 loans that are part of the pre-sale foreclosure inventory, and there are 4,427,000 non-current home mortgages in the United States, by LPS’ assessment.
According to the company’s state-by-state breakdown, Mississippi has overtaken Florida as having the nation’s largest population of non-current loans, totaling 15.1 percent. Mississippi’s foreclosure inventory rate through October is just 2.1 percent, but it’s delinquency rate is 13 percent—the highest in the nation, by far.
Florida took the top spot on LPS’ list of states with the most non-current loans in 2008, displacing Mississippi. Since then, Florida held that spot, reining as the nation’s nonperformance leader for more than five years, up until last month.
Excluding the last five years, Mississippi has held the dubious distinction of having the highest non-current inventory as far back as LPS’ historical data goes. So, unfortunately for Mississippians, the company says, this is more indication that things are getting back to “normal.”
A sheriff should go after the Constable, the WSJ idiot writer of this easy money toxic swamp that is the adjustable mortgage.
U.S. Negative Equity Rate Falls at Fastest Pace Ever in Q3
According to the third quarter Zillow Negative Equity Report, the national negative equity rate fell at its fastest pace in the third quarter, dropping to 21% of all homeowners with a mortgage underwater from 31.4% at its peak in the first quarter of 2012. In the third quarter of 2013, more than 1.4 million American homeowners were freed from negative equity, and 4.9 million mortgaged homeowners have been freed since the beginning of 2012. However, roughly 10.8 million homeowners with a mortgage still remain underwater (Figure 1). Moreover, the effective negative equity rate nationally — where the loan-to-value ratio is more than 80%, making it difficult for a homeowner to afford the down payment on another home — is 39.2% of homeowners with a mortgage. While not all of these homeowners are underwater, they have relatively little equity in their homes, and therefore selling and buying a new home while covering all of the associated costs (real estate agent fees, closing costs and a new down payment) would be difficult (Figure 2). Of all homeowners – roughly one-third of homeowners do not have a mortgage and own their homes free and clear – 14.7% are underwater.
The aggressive quarterly drop in negative equity in the third quarter was driven by high rates of home value appreciation, especially in regions with large numbers of underwater homeowners. Some of the hardest-hit markets during the housing bust have been showing the highest rates of home value appreciation, despite recent slowdowns in appreciation rates. Negative equity has been creating some unique dynamics in the housing market. Figures 3 through 6 provide an overview of the trends we have been observing.
Is Negative Equity Part of the New Normal?
Fast-paced price increases have helped bring many underwater homeowners afloat. In the third quarter, 1.4 million homeowners rose to the surface as their home values once again outranked their equity, according to the Zillow Negative Equity Report released Thursday.
The third quarter drop in negative equity rate was the largest on Zillow’s record, which dates back to the second quarter of 2011.
The negative equity rate now stands at 21 percent, down about one-third from its peak of 31.4 percent and from 23.8 percent in the second quarter, according to Zillow.
“Rising home prices and a greater willingness among lenders to engage in short sales have both contributed substantially to the significant decline in negative equity this quarter,” said Stan Humphries, chief economist at Zillow.
“We should feel good that we’re moving in the right direction and at a fast clip,” Humphries said.
However, with analysts—including Humphries– predicting moderating price gains in the coming year, that “fast clip” is set for decline.
In fact, Humphries says negative equity will remain a persistent trait of the housing market and become “part of the new normal” for several years.
While 4.9 million homeowners have risen from underwater since the negative equity peak in 2011, one in five homeowners with a mortgage remains underwater today, according to Zillow’s data.
That’s about 10.8 million homeowners currently in a negative equity position.
The “effective” negative equity rate is even higher at 39.2 percent in the third quarter, according to Zillow.
The “effective” rate includes all homeowners who have less than 20 percent equity in their homes. This rate is significant because selling a home and purchasing a new one “requires equity of 20 percent or more to comfortably meet related expenses,” according to Zillow.
More than half of underwater homeowners are underwater by at least 20 percent, Zillow stated. Assuming Zillow’s estimate for home price growth at 3.8 percent over the next year, it will take a homeowner with 20 percent negative equity five years to rise to the surface.
Of the nation’s 30 largest metros, those with the highest concentration of negative equity are Las Vegas at 30.6 percent, Atlanta at 38.2 percent, and Orlando at 34.2 percent.
Senate rule change opens door for Watt confirmation: report
If confirmed to head the agency that regulates housing finance giants Fannie Mae and Freddie Mac, Democratic Representative Mel Watt could open the door for the taxpayer-controlled firms to provide greater mortgage relief, in line with White House economic goals.
The current head of the Federal Housing Finance Agency, Edward DeMarco, is a career civil servant who has knocked heads at times with the Obama administration on homeowner-relief programs as he has sought to conserve the companies’ assets.
That focus has endeared DeMarco to Republicans, who successfully blocked Watt’s nomination in a vote last month. The filibuster marked the first time since the Civil War that the Senate failed to confirm a sitting member of Congress.
The Republican action helped spur Senate Majority Leader Harry Reid, a Nevada Democrat, to push through a change in the Senate filibuster rules on Thursday.
Previously, 60 votes were needed to clear procedural hurdles in the 100-seat Senate. Now, a simple majority suffices for all but Supreme Court nominees – a change that virtually guarantees Watt’s confirmation given that Democrats control 55 votes.
Homeowner and consumer advocacy groups have lobbied hard for Watt’s approval. They argue that DeMarco, who became the FHFA’s acting director in 2009, has not implemented programs that could help borrowers who are having trouble making mortgage payments.
Where the Empty Houses Are
The 2013 third quarter Census Homeownership and Vacancy survey shows that the vacancy rate is still above its pre-bubble level and remains unchanged from one year earlier. This might come as a surprise to house hunters, who have struggled with limited inventory when trying to find a home to buy or rent, but an unusually high share of vacant homes today is being held off the market. The elevated vacancy rate discourages new construction activity and is therefore one of the major hurdles to a full housing recovery.
To understand why vacancies are still widespread and what impact they have, we dug deeper into the Census data as well as other data sources that report vacancies at the metro level. Here’s what we found.
Nationally, Vacancy Rate Still Above Pre-Bubble Level
In the third quarter of 2013, 10.2 percent of housing units were vacant, excluding vacant homes that the Census classifies as “seasonal,” such as beach homes. Vacant homes include those for sale or for rent, as well as homes “held off market” for various reasons. This vacancy rate of 10.2 percent – the share of homes that are empty – was unchanged from 2012 Q3 and well above the pre-bubble level. In fact, the vacancy rate today (10.2 percent) is closer to its peak during the recession (11.0 percent in Q3 2010) than before the bubble (8.8 percent in Q3 2000).
But wait – aren’t homes hard to find? Buyers (and renters, too) have had little to choose from because the listed inventory is low. The share of the overall housing stock that is listed for sale, based on National Association of Realtors and Census data, rose slightly in 2013 Q3 compared to last year but is lower than at any other point during or after the bubble. In other words, the for-sale inventory is back down to its 2000 level, and tight inventory has helped fuel sharp price increases across the country over the past two years. That means there’s an inventory shortage, but not a housing shortage:
JP Morgan Chase bought Bear Stearns and WAMU for pennies on the dollar of book value. They thought they were getting a great deal, which is why they did it. Now that these deals turned out to be crap, they are trying to rewrite history and make it look like they were behaving altruistically and doing the government a favor, probably laying the groundwork for another bailout.
JP Morgan Bought Two Banks of Death
If you revisit old HW coverage of the Bear Stearns meltdown back in 2008, it is obvious that while JPMorgan Chase (JPM) voluntarily entered the deal to buy the beleaguered investment bank, it did so at a time when federal regulators were on the prowl to stop the bleeding.
JPM’s Bear Stearns-buy did in fact stop the bleeding for a while at least. Past coverage suggests a ‘historic arrangement’ was made between the Fed and JPM, with Jamie Dimon’s company paying a low amount per share for the failing Bear Stearns. No doubt it kept the government from sweating it out at the time.
But after witnessing JPM’s $13 billion settlement with the Justice Department and other regulators—mostly over mortgage issues tied to Bear Stearns and WaMu—it seems unlikely it’s a good business decision for banks to bailout other struggling banks. Yet, the truth is the government doesn’t mind these bailouts when they’re happening.
But after seeing very little sympathy in the form of evaluating successor liability from the standpoint of which firm did what, it seems banks should just let their brethen fail even if it means letting down financial regulators. After all, acts of chivalry are for humans not banks, so don’t expect applause thereafter.
Bank analyst Nancy Bush with NAB Research LLC describes JPMorgan at the time of its Bear Stearns acquisition as a firm “trying to be a good corporate citizen.”
Senate Banking Committee Approves Yellen Nomination for Fed Chair
The Senate Banking Committee has voted to approve Janet Yellen’s nomination to chair the Federal Reserve, bringing Yellen one step closer to being the first woman to serve as head of the country’s central bank.
The committee approved Yellen’s nomination by a vote of 14-8, passing it to the Senate floor for a final vote.
Currently serving as the Fed’s vice chair, Yellen is viewed by many on Wall Street as a “dove” on monetary policy
who is more concerned with unemployment than inflation.
In her nomination hearing before the committee on November 14, she defended steps the Fed took to stabilize the economy following the economic crash, putting an emphasis on the number of jobs regained. Like her predecessor, Ben Bernanke, she is expected to push for accommodative monetary policy as the economy slowly recovers.
With Senate Democrats and several Republicans supporting her nomination, her confirmation seems likely.
In remarks given at the approval hearing, Senate Banking Committee Chairman Tim Johnson (D-South Dakota) praised Yellen, calling her “a model candidate for Chair of the Fed.”
“As we saw in her testimony last week, Dr. Yellen understands the challenges facing our economy and the balance the Fed must strike as we navigate the path back to full employment,” Johnson said. “I am proud to offer my support for Dr. Yellen to serve as the first female Chair of the Federal Reserve.”
Desperate M&T Bank Takes Action to Help Unemployed Borrowers
Who ever heard of banks helping their unemployed borrowers find jobs? Though this may be hard to believe, this concept is becoming a reality thanks to a company in Bend, Oregon, named NextJob. This company’s motto is “A job for every person and a person for every job.”
Realizing that job loss in the current economy is the major reason homeowners default on their mortgages, management of M&T Bank in Buffalo, New York, announced Thursday that they will be offering a pilot program of NextJob’s services to their unemployed borrowers at no cost.
Participants will work directly with a NextJob coach to develop a detailed job search action plan, create an effective resume and cover letter, and analyze career direction options.
They will also be trained to identify skills that could transfer to another industry or field, discover “hidden” jobs that are open but never advertised, learn how to effectively use the latest in internet tools, and prepare for successful interviews.
“We were impressed with the services offered by NextJob, and as a bank committed to the customers and communities we serve, we felt this would be an effective program to offer our unemployed borrowers,” explained Mark Mendel, SVP Customer Asset Management.
In 2012, Fifth Third Bank, Cincinnati, Ohio, was the first bank in the nation to work with NextJob on implementing this innovative reemployment training program. Borrowers who participated in the initial pilot program had been out of work for approximately 22 months. After completing the training, almost 40 percent of participants were fully employed within six months. Because of this success, Fifth Third Bank expanded the program bank-wide in February of this year.
According to John Courtney, NextJob president, “Job loss remains one of the top issues in our economy and is responsible for half of mortgage defaults, which are the number one debts in America. Our reemployment program is a natural opportunity to make an impact in alleviating this problem.”
Courtney explained, “We developed this idea four years ago, and conducted a pilot program two years ago. We now have three banks participating and by December, we will have four. “He said that momentum is accelerating for this remedial program as more banks and lending institutions learn about it.
Have to agree / disagree on this one. I refinanced my own dear elderly mother on an Option ARM back in 2005. It made perfect sense for her at the time and worked out for her in both the long and short run. I understand that exceptions do not prove the rule, but there are thousands of examples I could bore you dear reader with if you needed some. There was a place for those loans then, as there is today.
That said, ARM loans, like handguns, are not for everyone. Sure, you may have played with financing multiple homes in the past – just as you had a toy gun as a kid. We’re no longer children here, and when that ARM goes off – as handguns sometimes do, you need to accept the consequences.
I never sell ARM loans as “well, you can always refinance” (pro tip: no you can’t). or “you’ll probably move in 5 to 7 years (really? OK Karnak, what are tomorrow’s MegaMillion numbers). Anyone who follows that advice is being pulled by to doom by listening to the siren’s song.
Rationally speaking, some ARM caps make the case for taking up these loans. If you start at 3.0% for 7 years, with a 2% cap per adjustment, compared to a 4.25% 30 fixed, you’re ahead of the game well into the next decade even with a worse case rate change scenario.
As with any financial instrument, NEVER TAKE THE ADVICE OF SOMEONE WITH A VESTED INTEREST IN THE OUTCOME. Sure, get the numbers from them, look at all possible choices, then run your thoughts past a trusted adviser before moving ahead.
My .02c
Soylent Green Is People
You are correct to point out the details matter. If someone could get a 3% ARM with a 2% cap adjustment limit, I would recommend that loan over a fixed loan at 4.25%. In all likelihood, the 3% ARM will adjust to 5%, but the short term savings will make up for the long-term increased cost because the cap is so low relative to current fixed rates.
I’m also glad you pointed out the bad reasons to take out ARMs and their dangers because those bad reasons are exactly what will be thrown at a potential borrower by a bad agent trying to close a marginal deal.
What is the typical top cap on a 3% ARM? 7%?
One bright spot out of financial reform is the change in ARM caps. Almost every lender is moving to a 2/2/5 cap structure
2% first adjustment
2% max per year thereafter
5% lifetime cap from 1st adjustment (for the most part)
3.0 could become 5, with a 10 cap.
3.0 years 1-7
5.0 year 8
7.0 year 9
9.0 year 10
In a decade, your average rate is a shade over 4%. This assumes you’ve got a rising rate environment – which you should accept and plan for as a possibility.
I hold out the thinking that if we’re seeing a 9-10% mortgage rate (meaning a 6.5% 1 Year US Treasury / 1 Year LIBOR), I don’t care what rate you have on your loan, fixed or ARM, the economy has gone to hell in a handbasket and everyone is in trouble.
My .02c.
We used an ARM to buy back in 2000 on a house/mortgage we could not really afford, all on the speculation that home prices would rise and we could get out before the expenses overwhelmed us. It worked out.
Would I recommend it to anyone else? I dunno.
What if lenders hadn’t lost their minds and house prices hadn’t bubbled? What would have happened to you, your family, and your balance sheet?
90%+ of borrowers shouldn’t even hear about the option to choose an ARM. They need to be protected from themselves. However, there are exceptions to this rule. I would consider an ARM today, but the terms/details matter.
e.g. I would want:
1) the initial rate to be at least a point lower than the 30-year fixed rate;
2) the initial rate to last for at least 5 years;
3) the initial rate adjustment to be limited to 2 or fewer points; and
4) the lifetime rate adjustment cap to be limited to fewer than 5 points.
e.g. A 5/1 ARM at 2.5% = a $3,556 P&I on a $900k loan. The 4.25% 30-year fixed payment would be $4,427. I would save that $871 difference ($52k over 5 years) and prepare to pay-down the mortgage dramatically if necessary 7+ years out (remember, the max rate for year 6 would be 4.5%). I think this is a better plan/option than taking out a 15-year fixed mortgage.
Like an Option ARM, the product only works for those who have the financial discipline to use the savings to their advantage. Unfortunately, 98% of the population will use the savings to fund other lifestyle expenditures.
Well, when mortgage rates increase enough again they still have those mortgage acceleration products. Watch they will be back when mortgage rates increase above 6.5% again.
The Fed is really trying to get back there.
One year ago, mortgage rates hit lowest point in history
What difference does a year make?
For mortgage rates, it makes more than a full percentage-point difference.
One year ago today, on Nov. 21, 2012, the average interest rate for a 30-year fixed-rate mortgage hit 3.31 percent, the lowest rate on record–ever. This morning, the average rate is 4.22 percent, according to Freddie Mac’s Primary Mortgage Market Survey.
Even though today’s interest rates aren’t breaking any records, they are still historically very low. That phrase — “historically very low” — is casually thrown around a lot these days, but it’s true. Here’s why.
9% was a steal for more than a decade
Consider this: To take out a 30-year fixed-rate mortgage in the early 1980s, you had to pay a staggering 18 percent for the privilege. While 18-plus percent may have been abnormal, double-digit interest rates weren’t.
In the early 1970s, when Freddie Mac first started keeping record of rates through its Primary Mortgage Market Survey, interest rates were around 7 percent. But they began climbing in the mid-1970s before hitting their highest rate ever—18.63 percent—on Oct. 9, 1981.
Interest rates rarely fell below 10 percent from 1979 to late 1990.
But the 1990s saw a return to seemingly “normal,” and more important, stable interest rates: between 7 and 9 percent.
It wasn’t until the early 2000s that interest rates started to get labeled as historically low. In 2003, they headed down to the 5 percent range, and then hovered between 5 and 6 percent until late 2009, when they began a slow and steady march down into the 3s.
[Take advantage of today’s historically low interest rates. Compare mortgage rates from multiple lenders now.]
But those days are behind us, and it’s really a good thing. Interest rates have been organically low, thanks to a sputtering economy, and artificially low, thanks to the Federal Reserve’s stimulus program that helps keep them there.
(Back story on the Fed’s stimulus program: The Fed buys $85 billion in bonds every month from lenders. The lenders then have more cash available to loan, which essentially means more supply than demand and that keeps interest rates low because the banks are making their money in volume, not in price.)
Bank on it: Higher rates are headed up, probably soon
As the economy improves, no matter how slowly, interest rates will go up — in part because lenders know they can charge more, because people have more money, but also because the Fed will taper off buying these bonds that keep interest rates low.
Federal Reserve Chairman Ben Bernanke said in late summer that the Fed would initially start tapering off its bond-buying program this fall, but he wound up backing away from that on the heels of lower-than-expected job growth reports.
When lenders finally realize their folly at the end of a massive credit expansion, there is often a sudden and dramatic credit crunch as credit availability dries up. Lenders tighten standards suddenly at first, but they they continue to tighten slowly until delinquency rates on new loans fall to pre-folly levels. We may finally be there now.
Are We Finally at the Bottom of the Credit Tightening Cycle?
It’s no secret underwriting standards have tightened in recent years, and while many decry the heightened standards for making homeownership less accessible to some Americans, CoreLogic economist Sam Khater pointed out in a report released Wednesday that heightened standards are undoubtedly impacting delinquency rates for the better.
“While there has been much consternation about underwriting being too tight in the context of forthcoming mortgage regulations, one underappreciated outcome has been the very good performance of mortgages during the last few years,” Khater said in an article titled “Tight Credit Results in Flawless Performance,” which was part of CoreLogic’s most recent MarketPulse.
“Tighter credit results in flawless performance,” Khater said.
The serious delinquency rate, which includes mortgages 90 or more days past due, in foreclosure or REO, stands at 5.4 percent as of July, according to CoreLogic.
While still significantly higher than the historical norm of 1 percent, the current rate has come a long way since its peak of 8.5 percent in January 2010, according to CoreLogic data.
Taking an even closer look, Khater examines 2013 vintage loans and compares them to vintages from years past.
Over the first half of this year, the serious delinquency rate for loans originated this year was six basis points, according to Khater.
This is down drastically from the 108 basis points for loans originated in 2007, which is the worst year in the 2000s, Khater noted.
The current rate is also better than the rate recorded for 2003, a year when home prices were rapidly increasing. Serious delinquencies for 2003 vintage loans was 15 basis points, according to Khater.
Serious delinquencies for 2013 loans are also down from 10 basis points among loans originated last year.
“This clearly indicates that the most recent mortgage vintages are pristine relative to even the good performing years of the early 2000s,” Khater said.
At some point, delinquency ratios are too low, and lenders are missing opportunities to make money on loans. I think you’re seeing this in the large banks making 15% down no MI mortgages to qualified jumbo borrowers. I wouldn’t be surprised to see this extended to 80/10 mortgages to qualified jumbo borrowers with the rate on the second 150-200 bps above the first.
And that’s how it should be. Private money can only assess borrowing risk after we reach the bottom of the tightening cycle. Then they can try pushing the risk envelope at the margins and see what happens. By adding risk in small increments, they will start to feel the heat long before they really get burned.
I think you have it completely backwards. Lenders have been profiting from hapless borrowers getting stuck with fixed rate mortgages for the past 30 years. Your own graph is the clearest evidence of this. Rates have been in steady decline, so anybody locking in a fixed rate has been an absolute fool (and a very profitable one).
Your talk of serial refinancing also plays directly into lenders’ hands. Who do you think profits on a refinance? There is a major cost to the borrower. It’s usually at least 1% of the mortgage balance, plus the 30 year term reset that leads to more years of interest payments. (Cha-ching!) A borrower living a serial refinance lifestyle is a lender’s wet dream. Not only is it a steady stream of origination fees, more years of interest, and secondary market income, it also provides the chance to upsell a cashout to fix up the house, send the kids to college, or pay for that vacation they’ve always wanted. It’s encouraging the ponzi lifestyle you so despise.
Then the flipside are the millions of borrowers that failed to refinance and that are stuck in high fixed rates that you call “stupid and inattentive”. They are also very profitable.
Larry your advice is well-meaning but not very well thought out. If you define risk as the propensity to suffer losses, then a fixed rate mortgage can be just as risky as an ARM, sometimes much more risky. A borrower needs to evaluate their options and make a wise decision. There’s no substitute for being wise, not even cookie cutter advice like today’s blog.
I think Larry is spot on. Fixed rate on an AFFORDABLE mortgage and pay it off. For most folks, a home is a place to live. Speculating on home price appreciation can be a rough game. Larry, your well meaning advice has helped a ton of folks.
Mellow Ruse,
You’ve either lost your mind or your perspective, or perhaps both.
Are you genuinely asserting that borrowers using fixed-rate financing are fools being ripped off by the banks?
Borrowers with fixed-rate financing have enjoyed peace of mind from an assured maximum level of monthly payment and the flexibility to refinance when rates drop into an even lower payment. In short, they’ve enjoyed all the benefits of the adjustable-rate mortgage and none of the shortfalls.
The one and only reason anyone thinks adjustable rate mortgages has any advantage is because rates have steadily fallen for 30 years. Falling rates allows adjustable-rate borrowers to pocket the risk premium, which is great as long as rates drop. But what happens when rates rise for 30 years? That’s what’s coming.
I think you are grasping for rationalizations for why peddling dangerous loan products like ARMs is okay. When the rising costs of those ARMs start forcing people to sell, people who recommended these products won’t remember their victims, but their victims will remember them. Look at the anger many people have for mortgage loan officers who peddled toxic loans during the bubble.
Anyone who buys a house using fixed-rate financing today with a payment they can afford — something the banks must now do thanks to QM rules — those people know they will always be able to afford their house no matter what happens to interest rates.
Anyone who buys a house using adjustable-rate financing today will always live with the uncertainty about their ability to afford their mortgage. Always. Perhaps some will live on in blissful ignorance only to be rudely shocked by the reality of rising loan payments when interest rates rise. I wouldn’t want to be one of those people, and I don’t want anyone who reads what I write to be one of them either.
Oh my…. that is rich muchacho.
Please explain how in a secular, rising rate enviornment, a fixed rate mort can be just as risky as an ARM.
Thx in advance.
I think what Larry and M.R. are saying can both be correct. Most people purchasing with these arms’s do not understand the concept of Margin’s(although I am sure everyone on this board does). I worked in loans 10+ year’s ago. At that time, we were offering a product that was “6 month Libor” with a margin of just 1.0%. Although I was tempted to refinance out of my fixed rate, I didn’t do it. I had a friend who did, and I get to hear about his 1.35% loan every week. Below is a chart on the 6 month Libor for the past 10 years. The highest rate would have been 6.63% in 2006. It has been extremely low since. This loan adjusts every 6 months, so the borrower takes all the risk, but it sure has been a pretty 10 years for it:
Indeed, but past performance does NOT guarantee future results
In a secular, rising rate environment, a fixed rate mortgage can cost you a lot more money.
Losing money = Risk
Let’s pretend you have a younger brother named Franz. He’s looking to buy a starter home to live in for 5 years before moving up. The mortgage he qualifies for is exactly $500,000.
Here are his options:
30 Yr Fixed at 4.25%: Interest paid over 5 years = $101,620
5/1 ARM @ 2.875%: Interest paid over 5 years = $67,980
Franz has been reading this blog and has a healthy fear of ARM products so he opts for the “peace of mind” touted by Larry.
The cost of his peace of mind is $33,640 in interest payments.
But it’s actually a lot worse.
30 Yr Fixed at 4.25%: Loan balance after 5 years = $454,039
5/1 ARM @ 2.875%: Loan balance after 5 years = $443,512
By not opting for a lower rate ARM his loan balance amortized slower to the tune of $10,527.
So now the tally for his peace of mind is $44,167.
But it actually gets even worse.
30 Yr Fixed at 4.25%: P&I Payment = $2,460
5/1 ARM @ 2.875%: P&I Payment = $2,074
There’s also the opportunity cost on the payment savings. Each month Franz is paying $385 extra that he could have invested. Suppose he manages to get 8% returns on his investments, that’s $5,762 in lost earnings over 5 years.
The peace of mind tally is now at $49,929.
After 5 years, Franz sells his starter home and moves on, none the wiser about the 50 grand he lost. But then again, how do you put a price on peace of mind? Franz feels good, and even a little bit smart, about avoiding risk in a secular rising rate environment.
Listening to his older brother el O, cost him dearly…
That’s a good example, and the differences grow larger as the loan amount does, obviously.
Wells’ 30-year fixed jumbo rate is 4.125% and their 5/1 ARM is 2.375% – a wider spread than in your example!
https://www.wellsfargo.com/mortgage/rates
However, the mortgage interest deduction affects this discussion. On a $900k loan using these Wells’ rates, the gross difference in interest expense after five years is $76,746! However, for a borrower(s) in the 33% IRS bracket, that difference is really $43,435. Still large, but not nearly as large.
Soylent Green Is People says:
November 22, 2013 at 8:32 am
NEVER TAKE THE ADVICE OF SOMEONE WITH A VESTED INTEREST IN THE OUTCOME.
this is the bullshit touted by all the mortgage brokers slamming people into ARM loans back in the day.
the numbers are correct, but you are looking at best case scenario aka dreaming.
a rising interest rate environment is going to put Franz in a position where he (usually) has bought the biggest house he can afford, prices and economy have contracted, and now his payment is going to rise. I’d argue this situation represents substantially more risk than the savings he would have received from the ARM. He likely wont be able to sell unless he wants to lose his DP. He likely wont be moving up unless he has seen substantial wage increase. Now he’s locked into a house with a rising carry cost and cant understand why he was so stupid to get a bad loan.
we are in the eye of the hurricane economically. all problems have been papered over by ZIRP. Franz would be very wise to take a 30 yr fixed loan, and not listen to sunshine and lollipops mellow ruse whose ideas exist only because of his lack of understanding of monetary policy and his myopic view that real estate has bottomed in sustainable fashion.
additionally, his 8% investments may have underperformed or have gone tits up entirely, especially transitioning from current ZIRP environment to rising, and possibly drastically, interest rate environment. We are going to see just who is swimming naked as the recession/depression goes full swing.
Your example works in some circumstances when a person knows with certainty they are going to move within a specified timeframe. Of course, nobody really knows this, and if they did, they would probably be better off renting, but I will grant you there are some circumstances where the ARM borrower will come out ahead. If there were no reward, there would be no reason to assume the interest rate risk.
And what does the “wise” brother do in five years when his ARM adjusts to market and now he’s paying 5%? The money he may have saved during the initial lock period is quickly squandered on increased mortgage payments. He is either forced to pay more or sell his property.
And what if prices haven’t risen during that five-year period? Now he faces selling and losing equity due to transaction costs, or he must pay more for the same mortgage. If interest rates rise high enough to make his payment higher, then rising rates will also squash appreciation making it difficult to sell without a loss.
Further, if the borrower realizes they made a mistake with the ARM after the payment rises, they will find fixed-rate financing that much more expensive and also out of reach, so the ARM becomes a long-term commitment. The interest rate risk will haunt them for the entire cycle as interest rates rise.
I’ll take peace of mind over short-term savings. There is a crossover point, and I can’t say exactly where that is, but an extra $400 per month to lock the payment forever will feel like cheap insurance when rates go up.
BTW, Mellow Ruse, I do appreciate that you stimulate discussion of this issue and provide counter examples. It adds tremendous value to the post to see thoughtful analysis of the alternatives.
For the first time home-buyer like myself the whole process of getting a mortgage is really too much to handle. I had so many options, and the bank was willing to lend me almost triple the amount I wanted to borrow. It was very tempting and the bank was so accommodating. In the end I got a fixed rate with 20% down and a mortgage well within my means. The only bad thing is I won’t be inclined to refinance since I’m at a low rate already. The good thing is since I got what I could afford, the condo is small, I will be more inclined to move out when the kids are almost done with school into a cheaper neighborhood with a backyard.
I take IR’s blogs seriously but also read all the astute observations even yours, MR. Thank you all.
I don’t know if this is true, but I got this email to mortgage professionals. This is for private lender loans.
*On o/o refinances the borrower will have to pay the broker and lenders fees at the close with cash, cannot be financed through the loan.
*On o/o refi’s the borrower will need to supply a counseling cert from a HUD class.
For most loans they are Fannie or Freddie. However, if they ever get out and you need to go private, these conditions might kick in.
I could takes the cynics approach.
Everyone should borrow as much money as possible using the lowest rate 1-year ARM they can find. When their payments go up and they can’t afford the property, they file a lawsuit against the lender claiming the lender didn’t properly assess the borrower’s “ability to repay.” There is a good chance the borrower would either be granted a loan modification or be allowed to refinance into a fixed-rate mortgage at a below-market rate.
There’s always a way to game the system.
Why do you assume interest rates must go up in the future? Japan has held them at 0 for 20 years. The Fed will likely do the same (or even more). Current growth/inflation does not justify higher rates, and I don’t see anything on the horizon that changes this. In fact, it’s likely to get worse.
Plus who cares if your ARM resets and you cant afford your payment anymore. The federal gov will be there to fix that for you.
We were posting at the same time, check out my response above.
The precedent has been set now. Moral hazard is baked in, and the next front on this is student loans.
Yep, the current incentive is to take out the most student loans you can then appeal to the government for a bailout when your income can’t repay them.
I saw a recent bond analysis where the authors (Charles Schwab) posited interest rates here in the US would remain very low for many years because of shifting demographics. We have a baby bust generation of workers, so aggregate demand will be lower, so interest rates will be lower. This also explains much of why Japan has had such low interest rates for so long. They have actually been shedding population.
I don’t think we will see 10% rates any time soon, but I do believe they will rise from here, and people who borrow with ARMs won’t be happy about it.
How about inflation pressures from international factors? Like China? The cost of goods and commodities increasing to due their desire to purchase more goods.
Here’s where the issue of a realtor’s fiduciary obligation comes into play. If, in order to make a sale, a realtor tells a borrower “go floating rate…you can always refinance later” can a realtor be sued later if the borrower finds out he or she cannot refinance? That’s what I was getting at the other day. What if there are valid reasons why a floating rate loan is not good for that particular borrower…is a realtor incurring any liability by recommending something that turns out to be a bad idea?
Unfortunately, no, the realtor has no legal duty under that scenario. If they did, we would have seen millions of lawsuits after the bubble. They have a moral and ethical obligation, but you can see from their behavior how little that means to a typical agent.
Think about this scenario … if your ARM rate jumps, then inflation is running at a high level, your home is increasing in value, and your salary is also likely increasing.
Likewise, if your ARM rate falls, then the economy is weak, your job is at risk, and your house payment is falling.
Seems like the risks are mitigated. In general, you get rising rates when things are good. And, you get falling rates when things are bad … just when you need them.
Nothing worse then being locked into a fixed when rates are falling because of a weak economy, and you can’t refinance because your home wont appraise.
The only problem with ARMS was during the crisis … LIBOR ran away because of default risk in the banking system. Can that happen again? Possible, but very unlikely. That was a 100 year event.
Prospects Dim for Bills to Delay Flood Insurance Rate Hikes
Efforts to delay implementation of changes in the federal flood insurance program have run into roadblocks on both sides of Capitol Hill.
The leaders of the House Financial Services Committee say they are standing behind last year’s bipartisan legislation to put the flood insurance program on sounder financial footing even as the implementation of the law has sparked a chorus of complaints from constituents fearing spikes in premiums and plummeting home values.
In the Senate, attempts to call a quick floor vote on legislation to delay the changes in the program — designed to force higher premiums on properties especially at risk of flooding — appear to face opposition from both Democrats and Republicans.
Sen. Mary Landrieu, D-La., wants to add the measure to an unrelated defense policy bill, but Majority Leader Harry Reid, D-Nev., is restricting the ability of senators to offer unrelated amendments. Meanwhile, Republicans are unlikely to allow a vote that could give Landrieu, who faces a tough re-election bid next year, the chance to claim political credit.
The curbs on taxpayer-subsidized flood insurance rates are a case study in what happens when Washington takes away a government-sponsored benefit that helps a relatively small group of people.
About 1.1 million homeowners — or 1 in 5 in the program — have received taxpayer-subsidized rates and the government has financed about 60 percent of losses on their properties. Most people can retain the subsidies but can’t pass them along to people buying their home, a restriction that’s especially burdensome to lower-income older homeowners seeking to sell their houses.
The changes also promise to make it unaffordable for people in chronic flood zones to keep their homes, and they have put a damper on home sales in areas where benefits extended to current homeowners can’t be passed along to prospective buyers.
[…] Lender propaganda campaign extolls adjustable-rate mortgages – OC Housing News Here's an example of how much that can cost you. If you took out a 30-year mortgage in January 2003 the average fixed rate was 5.92%, according to Freddie Mac. Ten years of interest and principal payments on a $200,000 mortgage would have cost you $142,660. But if you went with a one-year ARM, which kicked off at 3.99%, according to Freddie Mac, after resetting each year the total cost would have been $119,181. That's a savings of $23,479. […]
I always use adjustable rate mortgages and they have worked out well in 2 ways:
1) They allowed me to purchase beach properties that I could not have afforded with a fixed;
2) They allowed me to take advantage of falling rates, which came in especially handy during the recession.
In today’s low rate environment, ARMS are not as attractive as they were. I would still use them to acquire a better property, but in todays rate environment, I would look to flip out as soon as the property appreciated enough to qualify.