Jan292014
Lenders peddle five-year teaser rates on toxic mortgages
Lenders want to pass interest-rate risk on to unsuspecting borrowers while working within the confines of the new qualified mortgage rules. Although some borrowers claim to understand the risks, if their bets prove wrong, most will petition for bailouts, and they have every reason to expect to get one.
For every good law, shysters find a loophole. Bankers proved, time and again, they will develop “innovative” loan products, designed to generate fees, which borrowers invariably fail to repay because disguised somewhere in the terms, a provision causes loan payments to increase, the borrower can’t afford the new payment, and the borrower defaults. The new qualified mortgage rules attempt to reign in the worst of these abuses, but on the margins, these rules leave enough wiggle room for lenders to brew a new batch of somewhat less toxic loans.
What risks should borrowers be allowed to take?
Most homebuyers using mortgages don’t believe they are taking a risk: they expect house prices to rise; they expect interest rates to fall; they expect to be bailed out if their expectations are met with an unpleasant surprise, and borrowers legitimately should expect bailouts given the new moral hazards engendered by everyone’s reaction to the housing bust. Of course, such moral hazard emboldens even greater risk taking and further destabilizes the system, but until housing finance blows up again and the assumptions everyone has about risk are tested, borrowers safely place blind faith in bailouts as risk mitigation.
Let’s assume for a moment that borrowers are mistaken in their beliefs; let’s assume no bailouts are forthcoming, and the terms of these new semi-toxic loans on the fringes of the qualified mortgage rules cause mortgage payments to dramatically escalate. In such circumstances, borrowers will either pay more or lose their homes. People today knowingly take these risks for the benefit of lower payments and occupying houses they otherwise couldn’t afford. How should we respond to these people if the risks they take cost them their homes?
Borrowers who take on the risks of adjustable-rate mortgages are likely to face higher interest rates and larger payments in the future. When that happens, and they struggle against the higher payments, they will conveniently forget the benefits they received for many years by using this dangerous financing, and they will whine and complain about how they didn’t understand the loan terms or some other such nonsense, and they will demand a bailout. Depending on where home prices are relative to the outstanding loan balance, they may be offered a loan modification, particularly if they are underwater; however, if the borrower is not underwater, lenders will likely tell the borrower to pay up or get out.
If future bailouts are denied because the borrower has equity — and such bailout requests should be denied — many borrowers will lose their homes. Of course, if enough borrowers suffer this fate, prices will fall, and lenders will be amenable to loan-modification bailouts, but in the end, people who buy homes they can’t afford will lose them. Should we let borrowers succumb to the pain of their own foolishness?
The conservative in me says they should reap what they sow and lose their homes. The liberal in me says we should regulate mortgages to prevent people from sowing the seeds of their own destruction; the standards of qualification for an adjustable-rate mortgage should prevent any borrower from facing unaffordable payments. Right now, the ability to repay rule and other qualified mortgage standards only require the terms to be affordable for the first five years, beyond five years, borrowers are on their own.
A Five-Year Wait for a New Rate
Lenders are touting the 5/5 jumbo adjustable-rate mortgage as a safer bet for home buyers, but critics say it’s a ‘crapshoot’
AnnaMaria Andriotis, Jan. 23, 2014 9:07 p.m. ET
Wealthy home buyers are encountering a new pitch: an adjustable-rate mortgage with a twist.
Known as the jumbo 5/5 ARM, this loan has a fixed interest rate for the first five years before it resets to a new rate that the borrower ends up with for another five years. The process in most cases repeats throughout the life of the loan.
Lenders say this mortgage provides borrowers with more certainty because the required monthly payments don’t change as often as they do on other ARMs. Borrowers, therefore, are less prone to interest-rate swings. Many lenders are also touting 5/5 ARMs as a hedge against rising mortgage rates, telling borrowers that at the point of reset they stand to receive a rate that may be lower than those they’ll incur if it adjusts annually.
The rate might be lower in five years? If the lender really thought that, they would be encouraging borrowers to take out fixed-rate mortgages. This is a bullshit sales pitch designed to pass risk to unsuspecting and foolishly optimistic borrowers. Shameful.
But the opposite situation could also play out, with borrowers locking in a rate for five years just before rates start to drop. Critics say this mortgage only works in borrowers’ favor if they happen to time the market right. “It’s a crapshoot,” says Keith Gumbinger, vice president of mortgage-info firm HSH.com.
I had a so-called expert tell me the whole ARM reset problem was overblown during the housing bubble because when those loans reset, many payments actually got smaller, so people were wise to take out adjustable-rate mortgages back then; shocked at his ignorance, I was speechless. Interest rates were already well below normal in 2006, and nobody expected a zero-interest-rate policy from the federal reserve to bail everyone out; borrowers using adjustable-rate mortgages during the housing bubble were not wise — they were lucky.
The pitch for 5/5 jumbos comes as lenders try to drum up wealthy home buyers’ interest in ARMs. Banks stand to earn greater returns with these loans, which they hold on their books, once interest rates start to rise, …
The inevitability of rising rates prompts lenders to bullshit its customers to make more money.
No closing costs helped convince Stephen Miller, a cardiologist in Salt Lake City, and his wife to refinance their $1 million fixed-rate mortgage into a 5/5 ARM with Zions Bank in December. Their rate dropped to 3.6% from 6.6% on their old mortgage. The Millers plan to sell their nearly 9,000-square-foot home in roughly five years so they don’t expect to be impacted by a rate change. “It’s a calculated risk,” he says. “But I also wanted the burden of financing to be as low as possible.”
Stupid is as stupid does. You can be sure these people will ask for a bailout when their calculations don’t go by the numbers.
To boost demand further, some lenders are rolling out so-called rate-reset protection. The feature allows borrowers who are concerned that rates will be significantly higher by the time their reset arrives to adjust their rate earlier than scheduled. But they’ll pay for the option. At PenFed, for instance, their rates will be a quarter of a percentage point higher than the market rates at the time.
More toxic terms people won’t understand.
Borrowers who are considering signing up for a 5/5 jumbo should compare the cap structures that each lender offers. One of the most favorable is a 2/2/5 structure, where the maximum amount the rate can change in the first reset (after the first five years) is two percentage points; the most the rate can change at each reset thereafter would also be two percentage points; and the greatest amount that the loan’s initial rate can ever increase by would be five percentage points. With this structure, a 5/5 jumbo with an initial rate of 3% could only rise to a maximum of 5% five years from now and its rate could never be higher than 8%.
If the interest rate increases by a full five percentage points, can borrowers reasonably afford the payments? This is the real risk of an adjustable-rate mortgage. Ask any of these borrowers at 3.5% if they could afford the payment at 8.5%, and the answer you’ll get is that they will just refinance if that happens. People who are that foolish deserve the pain they will endure.
Here are other issues to consider:
• Lender’s margin. When comparing 5/5 jumbos, ask lenders what index the loan’s rate is pegged to (such as a specific Treasury) and the margin that the lender tacks on.
• Matching discounts. Lenders are eager to originate these mortgages. Borrowers who decide to get a 5/5 jumbo should ask their lender to meet the discounts other banks provide.
The main issue to consider is whether or not a borrower is willing to risk losing their family home. Adjustable-rate mortgages carry the highest risk profile of any loan available today; when rates go up — and they will likely go up — borrowers face higher payments and risk losing their homes. Fixed-rate mortgages are the lowest risk option; the payment doesn’t change, so as long as the borrower can sustain a payment, they keep their home. Plus, if interest rates do go down, the fixed-rate mortgage borrower can always refinance to take advantage of the lower rates. It’s the best of both worlds.
[dfads params=’groups=164&limit=1′]
[idx-listing mlsnumber=”PW14014771″]
1823 West ASH Ave Fullerton, CA 92833
$399,000 …….. Asking Price
$500,000 ………. Purchase Price
7/11/2007 ………. Purchase Date
($101,000) ………. Gross Gain (Loss)
($31,920) ………… Commissions and Costs at 8%
============================================
($132,920) ………. Net Gain (Loss)
============================================
-20.2% ………. Gross Percent Change
-26.6% ………. Net Percent Change
-3.3% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$399,000 …….. Asking Price
$13,965 ………… 3.5% Down FHA Financing
4.41% …………. Mortgage Interest Rate
30 ……………… Number of Years
$385,035 …….. Mortgage
$108,096 ………. Income Requirement
$1,930 ………… Monthly Mortgage Payment
$346 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$83 ………… Homeowners Insurance at 0.25%
$433 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
============================================
$2,792 ………. Monthly Cash Outlays
($439) ………. Tax Savings
($515) ………. Principal Amortization
$23 ………….. Opportunity Cost of Down Payment
$120 ………….. Maintenance and Replacement Reserves
============================================
$1,981 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$5,490 ………… Furnishing and Move-In Costs at 1% + $1,500
$5,490 ………… Closing Costs at 1% + $1,500
$3,850 ………… Interest Points at 1%
$13,965 ………… Down Payment
============================================
$28,795 ………. Total Cash Costs
$30,300 ………. Emergency Cash Reserves
============================================
$59,095 ………. Total Savings Needed
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It’s betting time again today.
Fed taper will remain slow and steady: CNBC Survey
The Federal Reserve will continue to taper its stimulus of the U.S. economy by announcing a $10 billion reduction in its monthly asset purchases at each of its policymaking meetings scheduled this year, including the two-day session that starts Tuesday.
That’s the consensus forecast from 45 of the nation’s top money managers, investment strategists and professional economists who responded to this month’s CNBC Fed Survey .
An overwhelming 87 percent expect the Fed to taper by an average of $9.87 billion at this month’s meeting, roughly matching the $10 billion reduction, from $85 billion to $75 billion a month, announced after the the central bank’s December meeting.
Seventy-two percent of the survey’s respondents expect the Fed to announce an average $10.65 billion reduction after each of the rest of its meetings this year.
That scenario would cut the year’s quantitative easing to $460 billion from a bit more than $1 trillion last year and roughly lines up with the survey’s prediction that the Fed will buy $466.6 billion in assets this year.
Half of the respondents think that’s the right pace, with 29 percent preferring a faster taper and just 19 percent favoring a slower one.
While almost all those taking the survey expect incoming Fed Chair Janet Yellen to be equally or more dovish on checking inflation, 71 percent see the incoming Federal Open Market Committee as just as or more hawkish than last year’s members.
At the last several FOMC meetings, the consensus opinion has been completely and totally wrong. The fed has reasons to go either way on the taper.
The mathematical fact is that what cannot continue… won’t. 😉
ie.,
http://advisorperspectives.com/dshort/charts/markets/nyse-margin-debt.html?NYSE-investor-credit-SPX-since-1980.gif
That’s one of the scarier charts you’ve posted.
perhaps they can pull a couple more $10B tapers. it won’t work long term. but “all is well with economy” sentiment can remain fairly strong while they try to taper one or two more times. hopefully this will drive the price of gold down further. mellow ruse can continue thinking the gold bubble is over. gotta love it.
”Gold [is] an objective value, an equivalent of wealth produced.
Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs; upon virtue of the victims.
Watch for the day when it becomes marked; Account overdrawn.” -Rand, Atlas Shrugged ,1957
On January 23, 2014, what would have been the largest amount of gold withdrawn
in COMEX history, 321,500 ounces or 10 metric tonnes, was withdrawn from the JPM
eligible/customer account. It was not the largest withdrawl in COMEX history because 10 metric tonnes, which up till Jan. 23 was the largest amount ever withdrawn, was withdrawn from the JPM customer account on December 13th, 2013.
When a customer withdraws gold from the eligible/customer inventory at the COMEX, it is not just a paper transfer such as taking delivery of gold in the registered/dealer
inventory and either transferring it to another registered account or changing the
standing from registered to eligible. When a customer withdraws gold from the
eligible/customer account, they are taking actual physical delivery, aka backing
up the truck. A brinks or other armored vehicle rolls up to the vault location, loads up,
and off it goes. This is no cavalier operation, not because of the logistics,
but because by taking possession of the gold, the customer negates the eligibility of those bars for sale at the COMEX. That’s right. As soon as those bars
leave the COMEX vault, they can no longer be accepted as eligible COMEX inventory.
If the owner wanted to sell those bars on the COMEX, she would have to have the
bars melted at a COMEX approved refiner, recertified as eligible inventory, and
transported by a COMEX approved shipper to a COMEX approved vault.
In other words, that 20 tonnes of gold ain’t comin’ back. Unless those kilo gold bars were never physically in the COMEX inventory in the first place.
Equity doesn’t create affordability
The ongoing price recovery and rise in positive equity around the country has been cause for celebration among many industry commentators—but they’re not much comfort to those who continue to struggle to pay their mortgages, Fitch Ratings says in a new release.
While equity is an important factor in terms of borrowers’ payment behavior, Fitch reminds readers that income and ability to pay are also key.
“It is clear that rising home prices have had a positive influence on borrower behavior. However, some portion of borrowers still exhibit an inability to recover as the economy has moderately improved,” the agency said in its analysis.
Over the last two years, Fitch estimates the percentage of borrowers entering foreclosure with positive equity has roughly doubled.
This trend is particularly evident in many of the residential mortgage-backed securities (RMBS) loans that have entered into the foreclosure process in recent years.
“In many cases, troubled borrowers with equity are unable to sell their properties because the proceeds of the sale would not be enough to cover the mortgage amount, the closing costs, and the backlog of missed payments,” the company explained. “Loans entering foreclosure today have missed roughly two years of payments on average, more than double the pre-crisis, long term average.”
Complicating the matter are today’s tighter loan underwriting and origination guidelines, which Fitch says could prevent many struggling borrowers from tapping their home equity to cover expenses.
“Under the existing regulatory framework, residential mortgage servicers have many tools at their disposal to help struggling homeowners. However, servicers are often left with few options other than foreclosure for borrowers who are unable to make regularly scheduled mortgage payments, despite their interest in remaining in their homes,” Fitch said.
“This is especially true in situations where borrowers have equity in the property and have payment problems even after loan modifications involving significant rate reductions.”
Demand for Adjustable-Rate Loans Expected to Rise
In the growing arena of adjustable-rate mortgages (ARMs), hybrid products continue to attract the most interest, Freddie Mac revealed in its 30th Annual ARM Survey.
As fixed interest rates continue on their upward path, ARM initial-period rates remain near historic lows—a stat the GSE anticipates will factor into borrowing decisions in the year ahead.
“Homebuyers have preferred fixed-rate mortgages the past few years because of the low interest rates and the certainty of the monthly principal and interest payment,” said Frank Nothaft, VP and chief economist for Freddie Mac. “As longer-term interest rates rise, ARMs with their lower initial interest rates will become more appealing to loan applicants.
“We are expecting ARMs to gradually gain back some favor with mortgage borrowers, with the ARM share rising to 12 percent of the home-purchase market in 2014,” he added.
ARMs accounted for about 10 percent of new home purchase loans in 2013, according to data from the Federal Housing Finance Agency.
Over the last year, the company’s data shows initial-period rate changes on hybrid ARMs have been influenced largely by the length of their initial fixed-rate periods, with the longer periods seeing the biggest increases.
According to Freddie Mac, the pattern “largely reflects term structure movements in the rest of the capital markets and the Federal Reserve’s monetary policy,” which has served to keep short-term interest rates low while allowing longer-term rates to lift.
Among all ARM products, hybrid offerings continue to enjoy the most popularity from both lenders and borrowers. The 5/1 hybrid—which features a five-year fixed-rate initial period before the rate resets annually—was the most common over the last year, followed by the 3/1, 7/1, and 10/1.
Less common, the GSE says, were ARMs in which the repricing frequency was fixed for the life of the loan—such as the 3/3 ARM, which adjusts once every three years.
No lender can make 3/1 ARMs if they’re solely originating QMs. The payment calculation for purposes of qualifying the borrower’s real income and ability to repay, requires an assumption that the fully-indexed rate increase the maximum amount allowed under the terms. That explodes the 3.5% starting rate fixed for the first three years to a likely 7.5% fully-indexed rate used to calculate the payment for which the borrower must qualify based on their real income today.
Naturally, lenders are going to stretch the QM rules as far as they can….which is why the CFPB should have created an iron-clad standardized mortgage requiring a 20% down payment, good FICO scores and a job. Period.
The whole “ability to repay” thing is just garbage that the banks have figured out how to get around already. What a freaking joke!
There’s no reason the gov (fannie and Freddie) needs to provide financing for mortgages. Let the banks do it themselves…or create a gov agency to do it. The worst scenario of all, is the system we have now, which allows the banks to create the loans and then pass them off to the taxpayer. It’s total ripoff.
I wonder if we’ll ever reach a point where crony capitalism goes too far. Our current system is messed up because the people who benefit from it buy the votes in Washington to keep the system in place. What has to happen before people wise up and vote out the politicians making these bad decisions?
we’ve already passed that point. the market just hasn’t figured it out yet.
a currency crisis and return to sound money & fiscal discipline are our only hope.
I don’t see a currency crisis as a hoped for outcome. I see it as inevitable, but not hoped for. It will create much misery. I hope a currency crisis will not occur, but since hope is not a good strategy, I am forced to plan for the inevitable.
Good point. By hope, I meant ‘path to legitimate economic recovery’.
The sooner we embrace the pain, which years of artificially cheap money have created, the better. If it takes a currency crisis to right the ship, so be it.
Famine ought to do it.
nah, they’ll just vote more EBT=)
sound money is the cure to rogue government. the population refuses to willingly choose sound money now, so it will be forced into sound money via currency crisis.
When famine strikes it doesn’t matter how much they put into those EBTs there won’t be anything to buy with it.
Can you imagine a country where the government would encourage the populace to pay off debts instead of merely service them.
The ATR rules are real – not garbage. Lenders are going crazy right now trying to determine what loans they can still make. Law firms that practice consumer financial services are too busy to even take on new clients!
The ATR rules do not prevent lenders from stretching loan terms for borrowers, but with every additional inch of stretch comes risk. The secondary market understands this and is currently imposing the QM standard on all sellers.
Case-Shiller Declines for first time in over a year
Despite experiencing a slight downturn—the first monthly decline in a year—home prices still turned in a strong performance in November, according to the S&P/Case-Shiller Home Price Indices released Tuesday.
On a monthly basis, both the 10- and 20-city composite indices saw a 0.1 percent decrease in November, marking the first decline since November 2012 and the breaking a nine-month streak of increases.
Nine of the 20 cities tracked in the indices posted positive monthly changes, while another nine reported declines. Two—Minneapolis and San Diego—were flat for the month.
Dallas, which saw a drop in prices in October, recovered to set a new index high, S&P Dow Jones Indices reported. Denver, which was climbing to new records only a few months ago, ended November 0.6 percent off its peak.
Even with national prices down month-over-month, “November was a good month for home prices,” said David M. Blitzer, chairman of the Index Committee at S&P Dow Jones Indices.
“Despite the slight decline, the 10-City and 20-City Composites showed their best November performance since 2005,” Blitzer said. “Prices typically weaken as we move closer to the winter. Las Vegas, Los Angeles and Phoenix stand out as they have posted 20 or more consecutive monthly gains.”
On a yearly basis, the 10- and 20-city composites were up 13.8 percent and 13.7 percent, respectively. The increases fell in line with the consensus forecast as reported by Bloomberg.
Again, Dallas outperformed with an annual return of 9.9 percent—the highest since its inception in 2000. Also standing out was Chicago, which posted an increase of 11.0 percent, its highest since 1988.
As of November, average home prices nationwide were back to mid-2004 levels, according to the index report. The peak-to-current decline for both composite indices remained at about 20 percent, while the trough-to-current recovery was about 23.0 percent for the 10-city and 23.7 percent for the 20-city composites.
The Case-Shiller release followed Black Knight Financial Services’ (formerly LPS) monthly Home Price Index report, which showed prices rising 0.3 percent month-over-month and 8.5 percent year-over-year in November.
More foreign bank run rumors. Ctrl-P
Bank Run Fears Escalate as Russian Lender Bans Cash Withdrawals
Fears of bank runs have escalated with the news that Russian lender ‘My Bank’ has banned all cash withdrawals until next week.
“Bloomberg reports that ‘My Bank’ – one of Russia’s top 200 lenders by assets – has introduced a complete ban on cash withdrawals until next week. While the Ruble has been losing ground rapidly recently, we suspect few have been expecting bank runs in Russia. Russia sovereign CDS had recently weakened to 4-month wides at 192bps,” reports Zero Hedge.
The source of the story is a person working inside the ‘My Bank’ call center, although officials for the bank have refused to comment.
On Saturday it emerged that HSBC was restricting large cash withdrawals for UK customers from £5000 upwards, forcing them to provide documentation of what they plan to spend the money on, a form of capital control that more and more banks are beginning to adopt.
This was followed by the story, which subsequently turned out to be false but caused market jitters nonetheless, that China’s commercial banks had been instructed to suspend cash transfers.
An IT glitch that prevented thousands of Lloyds Banking Group customers from withdrawing cash at ATMs in the UK also contributed to the concerns.
As we reported back in November, Chase Bank also recently imposed restrictions which prevent its customers from conducting over $50,000 in cash activity per month, as well as banning business customers from sending international wire transfers. Financial expert Gerald Celente said the news was a sign that Americans should prepare for a bank holiday.
Questions were already being asked of Chase after an incident last year when customers across the country attempted to withdraw cash from ATMs only to see that their account balance had been reduced to zero. The problem, which Chase attributed to a technical glitch, lasted for hours before it was fixed, prompting panic from some customers.
In November it was also reported that two of the biggest banks in America were stuffing their ATMs with 20-30 per cent more cash than usual in order to head off a potential bank run if the US defaults on its debt.
“forcing them to provide documentation of what they plan to spend the money on, a form of capital control that more and more banks are beginning to adopt.”
WTF? People now have to justify to a bank what they want to spend their money on?
What if the depositor says they plan a trip to Las Vegas where they plan to spend the money on gambling, booze, and hookers? Does the bank suddenly have rights to determine what people can spend their own money on?
I’m starting to think perhaps the mattress isn’t such a bad idea after all.
Bear in mind, once you deposit your money in the bank, it is no longer yours. You are simply a creditor, in a long line with many other creditors.
“Financial expert Gerald Celente said the news was a sign that Americans should prepare for a bank holiday.”
Ha! Gerald Celente is a total kook! I haven’t seen anybody quote him since his “crash of 2010” prediction failed to come true. Of course, he also predicted the world would end in 2011, 2012, and 2013. He makes weather forecasters and psychics look good.
No offense, but, you seem to be quite well versed on what the ”total kook” has had to say over the last several years. Very telling 😉
Yeah, the 5 second google search to see what this discredited phony has been up to is extremely telling. I can’t believe he’s still around.
Yet you provided no links from your supposed 5sec search to substantiate the failed predictions you made reference to in your original post. Even more telling.
I believe the blog software limits us to two links, and there are far more than that documenting his failed predictions.
Here you go muchacho:
https://www.google.com/search?q=gerald+celente+failed+predictions
That first article on this guy was great.
All is well in MellowRuseVille. Cheap money ether. Forward Recovery!
Irvine Renter,
Imagine how the bank lobbyists sold the idea to the CFPB that borrowers didn’t really need to put money “down” on a mortgage…or that FICO scores were unimportant.
“All you need is proof that the borrower has the ‘ability to repay'” they say.
Then the QM rule passes, and before the ink is dry they spring this 5-5 deal!?!
What an outrage! I mean, c’mon, the whole system is run by crooks. How can anyone not see that???
The ATR rules and QM standard don’t establish a FICO floor, but do require lenders “consider and verify” the credit score and the borrower’s reasonably ability to repay the loan.
The ATR rules and QM standard don’t establish a minimum down payment, but the rules do require that the ARM payment used to qualify the borrower be calculated conservatively based on the borrower’s real income. The lower the down payment, the higher the monthly payment will be. The lender must determine the borrower has the reasonable ability to repay.
You may scoff at the “reasonable” standard, but that is very consumer friendly and subject to serious time/costs to determine if litigation occurs. The further a lender stretches borrowers’ ability to repay (beyond what is reasonable based on decades of prudent lending guidelines), the greater the litigation risk they’re creating in their loan portfolio. Of course, you can always charge for this additional risk…
Speaking of “charging for the additional risk”:
http://www.bloomberg.com/news/2014-01-29/subprime-called-safer-makes-comeback-as-nonprime-mortgages.html
The 5/5 ARM sounds better than a 5/1 because the “fixed” period is 5-times as long; but anyone with half a brain can run through the scenarios and figure out how luck is required in all ARMs.
What if in 2019 there’s some shock that sends rates soaring, even if only temporarily, but right as your initial 5-year fixed term is ending? Your loan will be reset using that high index and fixed for the next five years, regardless of whether rates decline dramatically after that shock.
Of course, you can always refinance… 😉
Of course, they can always ask for a loan modification too… 😉
Anyone betting that interest rates five years from now will be equal to or lower than where they are now is an unbelievable optimist. Then again, I was shocked when the yield on the 10-year UST dropped below 4%! At that time it seemed incredible…how low could it go?
You should only make that bet if, 1) you understand it well and have considered all of the consequences and scenarios, and 2) you can afford to take the bet should the worst case scenario occur. The cardiologist in the article may be the appropriate borrower for this loan type.
Irvine Renter says: “Plus, if interest rates do go down, the fixed-rate mortgage borrower can always refinance to take advantage of the lower rates.”
You of all people should know that being able to refinance is never guaranteed. What if home prices tank again? What if bond markets seize up? Jumbos will be hit the hardest in that scenario. Nobody should ever get a mortgage thinking they will have the opportunity to refi out of a bad decision, including a high interest fixed rate mortgage.
The doctor in the story is making a smart decision because due to the 2/2/5 caps, he won’t even have the chance of reaching his prior rate of 6.6% until the second reset 10 years into the loan. Over that time he is saving hundreds of thousands in interest, accelerated amortization, and the ability to earn a return on the difference. I’ve posted the numbers on this blog before and the “insurance” against a rate reset that comes with a fixed rate mortgage is some of the most expensive insurance you can buy.
In other words, it’s a total ripoff to get a fixed rate mortgage unless you plan to stay in a property for greater than 12 years. Even then, the ARM borrower has a good shot at coming out ahead because the fixed rate borrower can only win if maximum rate increases occur, which isn’t guaranteed, no matter what your historical bond market chart says.
“…The doctor in the story is making a smart decision because due to the 2/2/5 caps, he won’t even have the chance of reaching his prior rate of 6.6% until the second reset 10 years into the loan. …”
That’s only true in the absence of other possible loan products. A 4.5% 30-year fixed-rate mortgage is likely available to him. So, we should be comparing the 4.5% fixed loan to the 3.5% 5/5 ARM.
The ARM loan still wins after 10 years in that scenario:
Jumbo Fixed
4.5% for 10 years
Total P&I payments = 608,040
Ending balance = 800,895
vs.
Jumbo 5/5 ARM
3.5% for 5 years then adjusts to 5.5% for 5 years
Total P&I payments = 599,891
Ending balance = 800,740
P&I Savings = 8,199
Ending Balance savings = 155
As you can see, it’s very close, but remember this is assuming a max rate increase. Anything less than a max increase, and the ARM wins by a wider margin.
Mellow Ruse,
I wouldn’t have a problem wtih ARMs if the caps were lower, and if the borrower were qualified on the maximum interest rate allowable under the cap. There is a crossover point where an ARM is less expensive than a fixed-rate mortgage, and I would consider such an ARM if the cap wasn’t so high it could ultimately cause the payment to be unaffordable.
Brnanke’s statement said that labor market conditions are improving and the unemployment rate is decling, so many times that it must be true. And the herd of sheeple will express no outrage. A lie told enough times becomes the truth.
Fed taper continues, acquisition cuts go deeper
The Federal Open Market Committee meeting minutes reveal the Federal Reserve is taking its taper of asset purchases a bit further, reducing monthly acquisitions of Treasurys and mortgage-backed securities by $10 billion total.
Starting in February, it will scale back agency MBS purchases by another $5 billion, acquiring the assets at a pace of $30 billion per month rather than $35 billion.
In addition, the Fed will add to it its holdings of longer-term Treasury securities at a pace of $35 billion per month rather than $40 billion.
“The committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate,” the minutes stated.
While the pace of reduction is not on a preset course, the committee said if incoming data broadly supports its expectations of ongoing labor market improvements, it will likely reduce the pace of asset purchases in future meetings.
Furthermore, the minutes reaffirm the Fed’s expectation that the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent will be appropriate as long as the unemployment rate remains above 6.5%.
Despite taper talk, Fannie, Freddie and Ginnie Mae bonds are on a roll, but no one is calling it a rally just yet.
More taper and the rate on the 10 year declines. How many expected that?
Why mortgage rates aren’t higher … yet
Mortgage rates will rise in 2014. At least that was what just about every housing analyst said at the end of 2013 and in fact is still saying.
The thinking was that a combination of new mortgage regulations and a pullback in bond-buying by the Federal Reserve would be the rocket fuel to lift rates off near-historic lows. The Fed announced Wednesday it would extend the so-called taper and cut its bond-buying by another $10 billion, to $65 billion.
And yet for the past month, rates have not really moved. If anything, they’ve moved slightly lower from their year-end level and now hover just above 4.50 percent for the 30-year fixed. That has some scratching their heads about where rates will move as we head into the usually busy spring housing market.
“The simple answer is that the rate hike due to the Fed’s tapering really took effect last May/June—despite the fact that the tapering didn’t begin until December,” said Guy Cecala, editor-in-chief of Inside Mortgage Finance. “There was no need to hike rates further.”
Cecala points out, that from the standpoint of the mortgage market, the Federal Reserve is still buying as big a share—and perhaps bigger—of new agency mortgage-backed securities production as it was six months ago.
That is because overall mortgage production is down. The rate jump at the start of last summer ended the refinance boom, and purchase originations are sluggish, as sales slow and all-cash buyers reign.
Total mortgage applications are down 52 percent from a year ago, according to a weekly report from the Mortgage Bankers Association. Refinance applications and purchase applications are down nearly 63 percent and over 12 percent, respectively. The average contract rate on the 30-year fixed was 4.52 percent last week, compared with 3.67 percent during the same week a year ago.
The Fed may have cut its mortgage-bond buying by $5 billion in January, but it has had no effect on rates for one simple reason.
“Other parties have filled the void, and then some,” said Dan Green, publisher of TheMortgageReports.com. “Mortgage bonds are rallying, and mortgage rates are dropping.”
The reason: As the stock market falls, investors head to the safety of quality assets such as bonds. Recent economic turmoil overseas has added to that movement and, consequently, to a rebound in Treasury-buying, which depresses yields. Mortgage rates generally follow the 10-year yield.
“A reduction of $10 billion or even $20 billion shouldn’t change the current situation where the Fed is buying a disproportionately high percentage of new agency MBS production,” Cecala said. “Again, the big factor is declining originations and new MBS production.”
As for any major policy changes in the mortgage market, they are unlikely at least this year.
Do you know how lucky we are to live in such interesting times? We are witnessing history and we have the privilege of dissecting it in real time.
It turns out that I am not the only one who can add 2+2.
IRA Confiscation: It’s Happening
“And like an unctuously overgeled used car salesman, he actually pitched Americans on loaning their retirement savings to the US government with a straight face, guaranteeing “a decent return with no risk of losing what you put in. . .”
Here’s the thing: according to the IRS, there is well over $5 trillion in US individual retirement accounts. For a government as bankrupt as Uncle Sam is, $5 trillion is irresistible.”
MyRAs can nestle up right next to the social security trust fund. Mandatory return free risk.
The only reason a jumbo 5/5 ARM wins over the FRM is the facts used in the scenario. I wonder if there really is a doctor with exactly $1M balance at 6.6%, or was this fictional character created for the story? Alternatively, the author scoured the globe to find just the right person for the story.
If current rates were compared, I don’t think it’s such a clear win for this loan product. I got a jumbo fixed last fall at 4.125%. There is no way I would trade that for a 5/5 ARM at 3.6%. Of course if they were offering a 3 point differential like the story, I would jump at a 1.125% fixed for 5 years, adjusting to 3.125% for the next five. By the time the rate adjusted to 5.125% at year 10, there wouldn’t be any principal left to pay interest on.
There is a lot of variation in rates between jumbo lenders. One rate sheet that I follow is San Deigo Credit Union which shows the 5/5 jumbo at 2.875%. They’ve been offering this product a lot longer than most others, so I believe they keep it on balance sheet.
I use my credit union’s rate sheet for reference (Wescom):
https://www.wescom.org/rates/mortgage.asp
They’re offering a 2.75% 5/1 ARM up to $1m. I’d guess this is for highly-qualified borrowers only, with 20% down.