There are a few words that continue to strike fear into the hearts of homeowners and buyers since the beginning of the trouble in the housing market: sub-prime, no-interest loan, negative amortization and on and on. One concept that continues to get a bad wrap is the adjustable-rate mortgage, or ARM. An ARM is a loan for which the interest rate on the note is periodically adjusted according to the cost for the lender of borrowing the money on the credit markets. As America reflects on the heyday of questionable lending, many are wont to blame the ARM for much of the crisis, citing it’s riskiness and instability; these same people consistently call for a return to more fixed-rate mortgages believing that these are inherently safer.
As time has passed, however, new numbers are showing us that it was not, in fact, ARMs that were one of the leading causes of the housing downturn. In a Senate banking committee meeting on Thursday, Paul Willen, Senior Economist and Policy Advisor at the Federal Reserve Bank in Boston, noted that “60% of the loans that foreclosed due to delinquency were fixed-rate mortgages. But even more importantly, of those other 40% of loans that were adjustable-rate mortgages, 88% — the vast, vast majority — defaulted when payments due were <strong>at or below</strong> the borrower’s initial payment amount. A little math shows that adjustable-rate payment shock was responsible for less than 5% of mortgages that were foreclosed due to delinquency” (The Atlantic, October 26, 2011).
Willen states without reservation that so-called “payment shocks” from the adjusting of ARM rates did not cause the crisis since rates did not only go up, but also down. What Willen cites as the primary cause of the turbulence are “life events” – job loss, illness, divorce – concurrent with falling house prices; this, he says, resulted in loss of equity in homes.
Now that ARMs are being redeemed, the general public may start to think about them differently, especially considering the phenomenal interest rates they offer. Rather than a wild beast that carries a borrower along on an uphill ride to higher payments, current ARMs have very reasonable rate caps; for instance, a 5/1 ARM can be around 3.5% as a base rate, and many can only expose the borrower to a jump in rates equal to .5% per year after the initial five years with a cap anywhere from 5% to 7%. From the days of 14% interest rates, this still ensures a borrower a great deal.
So while ARMs are working on rehabilitating their image, many in the homebuying American public could benefit greatly from them, particularly those purchasing condos or in urban areas for whom the average lifespan of a loan is around five years. While we should all learn from the lessons of the past few years and it’s respectable that those pointing fingers at ARMs are looking to be a bit more wary when it comes to borrowing, it’s best to get educated about what and whom is truly responsible for all the trouble, lest we miss out on a great opportunity.