ARMed & Dangerous
The above headline links to a CNBC article, and some macro pundits, like George Gammon, are using this data to imply that the end is near in the housing market – because we saw a similar surge in Adjustable Rate Mortgages (ARMs) prior to the 2008 meltdown.
But – today really is different, and I explain why below.
ARMs now comprise 11% of all mortgages, up from only 3% at the start of the year. And the reason is obvious: consumers can knock 1% or more off of their mortgage rate by taking an ARM instead of a 30-year fixed.
So, does this portend housing Armageddon?
Not even close.
The pre-2008 ARMs were primarily interest only, monthly adjustable, negative amortization and/or 2-year fixed (the kind that accompanied subprime loans).
Brokers Lied Like Dogs!
What made the pre-2008 ARMs especially bad was the fact that brokers back then lied like dogs about the terms of the loans, giving borrowers sky-high margins that caused their rates to adjust through the roof after the initial “fixed period/start rate” ended.
Many ARMs had artificially low “start rates” (that lasted 3 months to 2 years) that brokers would unscrupulously sell as “actual rates.” Because of this, unsuspecting consumers would get killed when the loans started to adjust. Worse, higher margins resulted in much higher commissions, so brokers had enormous incentives to mislead – and mislead they did!
Brokers also saddled borrowers with massive prepayment penalties that made it very hard to refi out of ARMs.
Today’s ARMs Have Longer Fixed Periods (Adjustment Caps Too)
Today’s ARMs have longer fixed periods of 5, 7, or 10 years – so they are far safer right out of the chute.
Further, the disclosures are much clearer – so there is no way for unscrupulous loan officers to mislead anyone about margins or anything else.
And lastly, most ARMs have a very reasonable initial adjustment cap of 2% or 5% for the first rate adjustment after the fixed period ends, a subsequent cap of 1% (every six months thereafter) and life caps of 5% (meaning the rate can never adjust higher than 5% over the start rate).
No Prepayment Penalty/Refi Very Likely
Another huge difference with today’s ARMs is the lack of any type of prepayment penalty – so ARM borrowers can refinance at any time.
And, I think the opportunity to refi is more likely than ever, based on comments by:
- Jeff Snider of Eurodollar University who says that the money supply is no longer inflated because banks are not lending, and the government is no longer doling out helicopter money. He also says inflation will wane for a variety of reasons.
- Barry Habib of MBS Highway who says a recession is coming soon to theaters near you, and that rates will fall as a result.
- Brent Johnson who predicted “sovereign debt crises” (in this recent and excellent Hidden Forces Podcast) in the future that will also very likely bring down rates sharply, like we saw play out with Greece and Cypress, for example, after the 2008 meltdown.
So – I love ARMs and think borrowers should too – with little fear. And, no I do not think the rise in ARM lending portends a housing disaster.
Founder/Broker | JVM Lending
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