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ARMs still popular
Although the Federal Reserve recently put a stop to its interest rates hikes, there is still much speculation to what is going to happen to the market.
The Fed has been raising rates since June of 2004, and many believe that this pause is only temporary, and they will keep going up in the future.
Since rates have been constantly on the rise, it would make sense that adjustable rate mortgages or ARMs, would be declining, but the opposite is just the case.
ARMs’ monthly payments depend solely on the interest rate environment. There is an initial fixed period in which the borrower pays a specific amount and interest rate, and then the mortgage payments “adjust” according to the current rates. This can cause a lot of problems for borrowers when interest rates are on the rise since their payments will just keep getting bigger.
The August 15, 2006 article by Ruth Simon of The Wall Street Journal, “Option ARMs remain popular in spite of risks,” discusses why these mortgagees have remained popular regardless of the dangers.
“Despite concerns from regulators, lenders continued to issue large numbers of so-called option ARMs during the first five months of the year, new data show.”
Option ARMs are a bit different from regular adjustable rate mortgages in that there are a few different payment selections you have.
“An option ARM is an adjustable-rate mortgage that gives borrowers multiple payment choices each month, including a minimum payment, an interest-only payment and a standard mortgage payment. The loans often feature a low introductory rate that is used to set the minimum payment in the first year.”
Many potential borrowers are attracted to these ARMs because of their extremely low introductory rates and the option of paying only the bare minimum for the first year. What these people forget about is that the interest rate changes after a certain amount of time and the payment can increase by hundreds of dollars, making it exceedingly difficult to make the monthly payment.
“Option ARMs accounted for 12.3% of mortgage originations through May, up from 8.4% in all of 2005, according to a new study by LoanPerformance, a unit of First American Corp.”
“The loans' popularity comes as rising interest rates are making them less attractive. Many lenders have boosted their introductory rates to 2% or more. Once the introductory period ends, the true interest rate on the loan can be more than 7%, according to HSH Associates, financial publishers in Pompton Plains, N.J. That is well above the current 6.64% average rate on 30-year fixed-rate mortgages, according to HSH.”
Analysts are pretty much baffled as to why people would want to take out an ARM when rates look like this, but for many it is there only opportunity to lower their monthly payments.
“‘It's hard to know why anybody would want [an option ARM] in the current rate environment,’ says Keith Gumbinger, a mortgage analyst with HSH Associates. Yet borrowers seeking to lower their monthly payments have few other choices. Given the narrow difference between short- and long-term interest rates, Mr. Gumbinger says, ‘there are very few products that...provide payment relief.’”
Although ARMS are still remaining popular, the numbers coming in show that people are having trouble paying monthly payments and foreclosures and defaults are on the rise.
“There already are signs that some borrowers who took out option ARMs are running into trouble. Foreclosure rates for option ARMs ‘are rising fast,’ although they are coming off very low levels, according to a report issued last month by Credit Suisse Group. Option ARMs are going into foreclosure an average of 10 months after the loan is made, earlier than for other types of loans, and that is ‘a cause of concern,’ the report said.”
People need to look at the big picture before taking out an ARM and analyze their financial situation thoroughly to make sure they can pay the bigger payments once the mortgage adjusts.