ORANGE COUNTY, Calif. — Buying a home these days can cost you an arm and a leg, but some opt for an arm.
ARM or adjustable rate mortgages, once considered one of the contributing factors that led to the Great Recession of 2008, are making a comeback. Realtors and mortgage brokers say the loan program is different this time around.
With mortgage rates rising — and rates expected to continue to rise — real estate agents are seeing more and more homebuyers consider and use the ARM financing option instead of the traditional 30-year fixed rate.
“The majority of my clients use ARMs,” said Abby Ronquillo, founder of NetRealty at Corona. “It’s their way of fighting high interest rates.”
Unlike a traditional 15 or 30 year mortgage with an immutable fixed rate, an ARM is a mortgage option that allows a borrower to lock in a lower interest rate (below a fixed rate) for a few years before he adjusts.
Most variable rate mortgage options offer five, seven or ten years. Once the ARM rate changes, the rate and the borrower’s payment generally increase or decrease depending on the state of the economy. For example, a borrower with a 7/1 ARM would have a fixed rate – or lower payment – for the first seven years before the rate change.
“It’s a good option for the right person in the right situation,” said Jeff Lazerson, president of Mortgage Grader in Laguna Niguel. “It’s so important to realize that lower interest payments can cause the payment to drop, especially in the large carrier market. There’s nothing wrong with that, but you have to understand that you don’t know what the rate will be at the end of the blocking period.”
According to Mortgage Bankers Association, the number of applications for using an ARM loan to buy a home in California was 11.1% in February 2022. The number of ARM applications increased by 6.2% in California year-on-year the other, the highest in the country. Nationally, the total number of RMA requests increased to 6.6% week-over-week ending March 25.
As of April 5, the national average 30-year fixed mortgage was 4.8%. The mean ARM 10/1 rate was 3.9%, according to Bankrate.
ARMs received a bad rap as one of the reasons for the mortgage bust and the Great Recession of 2008.
In one Brookings Institute studythe authors blamed the rapid increase in lending to subprime borrowers (borrowers who generally would not have been approved for a loan) and the introduction of short-term ARM products as one of the origins of the financial crisis.
The authors said lenders are handing out two- or three-year ARM products with low upfront payments that borrowers can refinance once the rate matures.
“These so-called ‘teaser’ interest rates were often not so low, but low enough to allow the mortgage to pass,” wrote Martin Neil Baily, Robert E. Litan, and Matthew S. Johnson. “Borrowers were told that in two or three years the price of their home would have risen enough to allow them to refinance the loan. as long as this continued, a loan-to-value ratio of 100% would drop to about 80% after a short time, and the household could refinance with a conforming or prime jumbo mortgage on more favorable terms.”
The problem is that the housing bubble has burst. Mortgage payments skyrocketed as the economy crashed, and many borrowers were unable to pay their new adjusted mortgage or refinance their way out. This led to a wave of foreclosures.
From 2004 to 2006, the share of ARMs was approximately 30% of mortgage purchases. The traditional fixed-rate mortgage rate was around 6% during that time, Joel Kan, associate vice president of economic and industry forecasting at the Mortgage Bankers Association in an email to Spectrum News.
“It was also around the time when mortgage supply was at all-time highs and underwriting was much looser and there were riskier ARM products,” Kan said. “Following the Great Recession of 2008 to 2010, policy has been much stricter (Dodd-Frank) and underwriting standards more stringent and borrowers have stronger credit profiles.”
Kan added that over the past 10 years, “we have seen a shift towards ARM loans with longer fixed rate periods, i.e. a move from 3/1 and 5/1 ARMs to a majority of ARM 7/1 and 10/1, based on our app data.”
Sheila Nufable, head of community loans at Bank of America Pasadena, said she doesn’t advise ARM loans for first-time buyers.
“A lot of my clients are focused on getting a long-term fixed rate,” Nufable said. “They don’t want to take that risk. They’re careful because the market is so volatile. They can’t predict what it will be like in five, seven or 10 years.”
Nufable said ARM loans are generally for investors or people who don’t plan to stay in their home for the long term.
“They hope to be able to sell the property before the rate expires,” Nufable said. “It’s a good product for investment homes or a second home. ARMs are for the riskier buyers.”
For Ronquillo, his clients with ARM loans are banking on lower payments during the introductory period and refinancing before the rate expires. She said ARM loan eligibility has become stricter and requires higher credit, FICO scores and healthy cash reserves. She also added that the typical homeowner would refinance every four to seven years, anyway.
“A lot of my clients understand the big picture — rates go up and down,” Ronquillo said, adding that one client is saving $1,000 each month with a 7/1 ARM loan instead of a 30-year fix. . “ARM loans are for highly qualified people. Before, there was only declared income to get an ARM loan. That’s why people get in trouble.”
Lazerson noted that whether a borrower chooses a traditional fixed rate loan or an ARM loan, with rising interest rates and high inflation, people should be careful with their money.
“The key is to be conservative,” Lazerson said. “Don’t stretch yourself, especially with ARMs. If you don’t have a lot of money left over each month. If you stretch your budget. Don’t. Don’t max yourself out. And if you’re not going to be conservative , make sure you have an exit plan.”