Adjustable Rate Mortgages Are Our Friends

by February 7, 2009 • 6 comments

Yes, I know what you’re probably saying already. Where has this guy been? Living under a rock somewhere? Hasn’t he heard the nightmare stories about sub-prime mortgages, option ARMS and “liar loans” and how all of these ultra-risky vehicles got us into the mess we’re in right now? Indeed, the media has placed much of the blame for the collapse of home prices and the ongoing foreclosure crisis on the loose credit and lax credit standards for the proliferation of these exotic mortgage products that now make up much of the toxic debt on banks’ balance sheets. Yet, somehow, the plain old adjustable rate mortgage that has been around for decades has been painted with the same brush as the other mortgage products and unfairly so. Let me explain why ARMs are still around, always will be around, and why they may be the best friends we have right now.

The complete evaporation of a secondary mortgage market for condominiums and their twin the condo-tels, has forced banks to develop new vehicles for financing these properties. This is where the in-house loans, or portfolio loans as we call them, come in to play. These loans accept the risk associated with condos as collateral in a market that has seen condo prices plunge in recent years and ignore other factors that Fannie Mae and Freddie Mac, along with all the mortgage insurance companies, deem derogatory. But banks can’t loan money on these properties forever when they have no market to sell the loans. Eventually, they would have no money left to lend and would simply have a fat portfolio of nothing but condo loans and no capital. Corus Bank, the owner of Laketowne Wharf, is a great example of this scenario. That is why banks, like the bank I work for, turn to ARMs – they provide interest rate protection to the bank while offering the consumer a quantifiable risk scenario where they can weigh the pros and cons and make an informed decision.

I have been a little perplexed lately when potential borrowers call to inquire about financing for a fantastic deal they are getting on a condo. When I explain I have two options, a 3/1 ARM at 6.00% or a 5/1 ARM at 6.75% there is often an immediate rejection of anything that isn’t a fixed rate and an inferred suspicion that I am some sort of snake oil salesman. Never mind there are no other options out there. What about the fact these ARMs have initial fixed periods at very attractive rates? What about the fact that there are no pre-payment penalties, (we want them to pay it off) very low fees, and annual and lifetime rate caps of 2% and 6% respectively? Do they even give me the opportunity to explain that the ARMs are tied to the 1 year Treasury yield which is one of the most stable indexes to be found having averaged 4.38% over the past twenty years? Do I have a glimmer of hope that they will listen to me explain how ARMs work and that if these ARMs were to adjust today they would actually go down? Nope. If it’s an ARM it’s snake oil and will lead them to financial ruin. Yet for those who don’t associate every ARM loan with housing horror stories and who weigh the pros and cons are using my ARM loans to scoop us fabulous deals on beachfront condominiums and stand to make substantial returns on their measured risk proposition. Did I say risk? Of course there is risk with an ARM. Rates could sky rocket in a worst-case scenario but given that the U.S. will probably keep short-term rates low for a very long time, the risk is acceptable.

No one wants you to take an ARM more than the bank someone once told me. Over the years I have found this to be more or less true from a banker’s perspective. So why have I, personally, taken out several ARM loans over the years? It is because that while an ARM provides some safety for the banks, it also provides opportunities to borrowers. Lower rates equate to qualifying for more loan. If I anticipate a rise in property values or an increase in my income, why not look at an ARM? But most significantly, when it is the only mortgage option available and there perhaps once in a lifetime opportunities on beach-front real estate, do ARMs not beg some consideration? ARMs are like bridges, they get us over an obstacle though we may not know what we’ll find on the other side. One borrower said to me recently when we were discussing the end of that bridge on a 5/1 ARM he was applying for, he poignantly stated, “If things aren’t better than this in five years then God help us all.” This lead me to reflect that the bank portfolio ARMs may not be a panacea but they do offer buyers, Realtors and bankers alike, a bridge to better times ahead.

For this and more, visit my blog at www.activerain.com/blogs/hpalmer

With over fifteen years of mortgage and real estate experience, Hunter Palmer has the knowledge and expertise to help home buyers and Realtors navigate the ever changing real estate finance landscape.

Print Story

Related Stories

Additional Financial Stories

More Ways to Connect with Us

Leave a Comment

{

6 Comments

}

1 Corus Watcher February 7, 2009 at 12:41 pm

Hunter ~ excellent discussion piece on ARM’s from the point of view of a mortgage advisor working with clients today. I would add the following.

ARMs have been misused by the borrower over the past 6-7 years to lower their interest and payment without a thought to what would happen at the end of the bridge you describe.

ARMs became viable in the late 80’s and 90’s because the nations homeowners became a mobile society, rarely owning a home longer than three years. The 3/1 and 5/1 ARM became a powerful tool for homeowners that expected to move or trade up.

The ARMs you are working with are tied to Treasuries. Wall Street banks issued ARMs tied to LIBOR. This has created many ARM holders to experience unusual volatility in their rates.

Consevative people will avoid any future risk, and the ARM presents future interest rate risk. In 2004 (before the influx of CA investors), my sister bought her first home in Phoneix. I strongly suggested she save 1/2 of 1% by taking the 5/1 year arm. It would allow her to take savings of $5,000 over that 5 years and reduce prinicpal. She was scared and took the fixed at 5.75%. Had she taken the ARM, she would be adjusting right now from 5.25% to 3.875% for the next full year. But these are unusual times. The low rates will “save” some ARM owners from painful resets.

The best course of action for any mortgage borrower is to match their specific financial plan with their selected mortgage. We are in this housing foreclosure mess because too many borrowers and lenders gave no thought to the borrowers ability to repay.

How long will rates remain low? We all know this is an unknown. If rates remain low, our greatest risk is hyperinflation brought on by the devaluation of the U.S. Dollar. And there is real risk to an ARM borrower approaching a reset in that event depending on what their rate is tied to. Borrower beware.

Reply

2 Corus Watcher February 7, 2009 at 1:37 pm

You said…. “But banks can’t loan money on these properties forever when they have no market to sell the loans. Eventually, they would have no money left to lend and would simply have a fat portfolio of nothing but condo loans and no capital. Corus Bank, the owner of Laketowne Wharf, is a great example of this scenario.”

Hunter, your desciption does not match Corus’ business.

Corus’ focus is as a lender to developers, not individuals. They do not sell their loans like many banks do on individual mortgages. Their focus was high end Condo’s, apartment buildings, office buildings and condo conversions. Most of their conversion loan business is now paid off.

Most of Corus’ book is first mortgage. They have very little mezzanine business. So when a developer fails, they usually turn over the building to Corus without any fight or foreclosure proceeding.

For the most part, Corus’ clients are extremely strong developers. Recent developer failures in their book have seen the developer stay on to close units in the building for Corus.

Corus had a plan to deal with failures. That is why they are still standing. They had very strong capital going into the recession and reserves inside their bank holding company to back that capital up. They have plenty of cash to fund the projects under construction and implement their stated plan for Laketown Wharf. They have launched a new web site for Laketown Wharf and hired a new management company. We should see additional signs of that plan soon.

I have studied each bank that has failed from January 2008 to the present. The common theme is individual mortgages, and housing development. The one bank in Kansas failed because they did not secure appropriate collateral on commercial and development loans in FL and TX. This is an area that Corus excels at ~ collateral.

Corus has about $4.6B in deposits that are currently not allocated to any lending purpose. They have not entered into any new loans since early 08, and those were for offices in DC. If the stimulus plan works, Corus will be in a great position to resume lending. If they continue their plan to to enter the individual mortgage business for condos in buildings they own a large piece of, they will be competing in a market that many banks have exited.

Reply

3 FisheadRay February 8, 2009 at 10:58 pm

Dear Corus Watcher:

You either have to be on the Corus payroll or you have to have Shares in the bank. You can’t be serious jerking on Hunter Palmers chain, by telling him financial history. He has been in the game long enough to know the rights and wrongs of the banking business.
Blowing smoke about how stong and great the financial condition is at Corus is not factual. The past quarter financial statement will be restated on March 12, 2009, just to give the bank a chance to correct the cooked books…Then the real facts will come out…the stock is worth less then 50cents a share….The Glickman family controls 40% of the stock. Sixteen months ago when they knew the game was over, they paid a Special Dividend of $57 million. They paid loan officers bonuses for loans not paid off. They made the biggest dumbest loans and concentrated its bets in the worst bubble markets, like Miami, Las Vegas, and P.C.B.
The only strong developer they have is , Hyperian Condos, they borrowed $1 billion and they will be lucky to pay back 50 cents on the dollar. And I am willing to bet you Silicon will not pay Corus a dime.
Corus will be out of business before the year is over.

“Purge the Rotteness, out of the System so that Values will be adjusted and enterprising people will pick up the wrecks from the less competent people”. Andrew Mellon, 1934.
History repeats itself….

Reply

4 Corus Watcher February 9, 2009 at 2:14 am

Ray,

Be carefull what you wish for.

If Corus goes, it will be because the economy has continued a damaging and precipitous downward decline, changing forever the economic landscape for the next 20 years. 300-500 banks will precede Corus on the path to receivership. If we go there, its likely that PCB will have an 50% drop in tourism.

Unlike you, I actually hope that Corus makes it because it will mean the economy in the U.S., and globally, has reversed course downward and stabalized.

I do not work at Corus. I have invested in Corus stock in the past. I have also traded it successfully. I have CDs at Corus. But I watch Corus’ business and their development partners because it is a proxy for how bad things are proceeding with the U.S. economy. It is also a firm indicator of how the upper middle class to wealthy are reacting to this financial crisis.

You are very confident that Corus will be out of business by 12/31/09. The only way you could know that is if you work for the Treasury’s Office of Thrift Supervision and you intend to put them out of business. Or one could assume you are not with OTS and that you are just pissed off because Corus kept your deposit on Laketown Wharf. Or you worked for the developer and they let you go. All sorts of assumptions could be made about you.

Andrew Mellon would also be shocked that mortgage brokers are able to provide adjustable rate mortgages.

Reply

5 Dennis Fuller February 10, 2009 at 9:37 am

Hunter,
I agree with you. ARM’s are a great tool when used responsibly and a high percentage of buyers with ARM’s did not misuse their loans. Our local condominium market seems more troubled by speculators who refused to close.

When the new conforming guidelines are fairly applied to all condominium projects, bank portfolio loans with adjustable rates will be the only loans available to most projects. I do wish that the conforming loan guidelines could be eased so that with today’s strict underwriting, condominiums loans would qualify for sale to the secondary market. It seems that Congress is going to do something to boost the real estate market; however, condominiums may be left out of the picture.

Reply

6 Xine February 10, 2009 at 5:14 pm

Seriously? You want to boo-hoo over people not giving you the time of day to “explain” all the ins and outs of ARMs to them??? You’re not happy that they really want a fixed rate loan… and you want us to be on your side about it? After the mess this economy is in? The last time we consumers let banks educate us on their loan products we all got screwed. It really doesn’t surprise me at all that prospective clients are skeptical and wary of ANYTHING that comes out of a banker’s or broker’s mouth.

Reply