Can Single-Family ARMs Give a Boost to the Housing Market?

Home mortgage applications are now into their fourth straight month of declines, dropping to the lowest level since 1997, as the 30-year fixed mortgage rate hit 6.94 percent – the highest level since 2002, the Mortgage Bankers Association reported Oct. 19.

The ARM share of all applications rose to 12.8 percent, its highest share since March 2008.

“ARM loans continue to remain a viable option for borrowers who are still trying to find ways to reduce their monthly payments,” Joel Kan, MBA’s vice president and deputy chief economist said in prepared remarks.

Given the rising, unpredictable nature of home mortgage interest rates, more industry followers are speaking to the option of adjusted-rate mortgages and whether they could inspire more home purchases.

The advantage of using an ARM in today’s market is that it could help consumers justify making the purchase, they said, or to keep the home they want to buy within their monthly budget.

Since an ARM truly is a risk/reward tool, consumers believe the reward of the lower monthly payment and reduction in interest payments is greater than the risk of their payment rising after the fixed period is over.

Keep in mind, they said, there is no one “best” ARM option for buyers. It’s a subjective question. Each borrower has their own financial picture, long- and short- term plans and goals for the home.

The guiding principle, according to Key Mortgage Services, is the shorter the fixed-in term, the higher the risk. So, planning out the pros and cons for the term length should play into what ends up being the best option.

The more popular terms Key Mortgage Services, for example, is seeing now are the 7- and 10-year ARMS, which are the longer options available (versus 5- and 3-year terms).

ARMs Provide Buyers with ‘Breathing Room’

Suzanne Ross, director of mortgage product, Ocrolus, tells GlobeSt.com, ARM loan programs are on the rise due to rising interest rates and an optimistic view that, within the next five years, a refinance to a lower rate will be possible.

“With rates likely to continue rising, ARMs are also expected to increase in popularity,” Ross said.

“Right now, we are in a volatile rate environment with a steepening yield curve and demand for homes still very high. ARMs allow buyers some breathing room to lock in a lower rate while shopping for a home, and they have the stability of a fixed payment for five or seven years while the economy cools down.”

Ross said that in a high interest rate environment, ARMs are worth considering over conventional loans.

“We are still seeing high demand for homes and low inventory, and ARMs allow buyers to lock in lower rates, providing them with more buying power. The reduced interest rate allows for a lower monthly payment and gives some peace of mind for several years.

“The likelihood of being able to refinance within five years to a lower or even the same rate on a 30-year fixed term is pretty high, and that is a gamble many homeowners are willing to take right now.

Crunching the Numbers

Realtor.com’s chief economist, Danielle Hale, said, “With the gap between the rate for a 5/1-year adjustable mortgage and fixed rate more than 1 percent, according to the latest data from Freddie Mac, home shoppers who are looking to maximize their buying power may consider an adjustable-rate mortgage.

“A buyer interested in purchasing today’s median listing ($427,000) with a 10% down payment will find that their monthly principal and interest payment is nearly $280 lower with the adjustable rate versus the fixed rate product.

“This translates into more than an extra $50,000 in buying power (i.e. you could buy a home priced up to $479,000 with an adjustable rate mortgage for the same monthly payment as the fixed-rate mortgage given today’s rates –data as of Oct. 13).

“At a time when home prices remain high and buyer budgets are squeezed, an adjustable-rate mortgage can be the difference between being able to make a home purchase or not, which is why these mortgage offerings are gaining in popularity.

Florida a Viable ARM Market

David Druey, Centennial Bank Florida regional president, tells GlobeSt.com that adjustable-rate mortgages (ARMs) can be an attractive strategy to lure homebuyers off the sidelines with a lower initial interest rate and monthly payments, which can feel more palatable as economic conditions shift.

“We are seeing customers strongly consider this product and take a deeper look into what lending options are available beyond traditional mortgages,” Druey said.

“Part of the draw is that in strong regions with anticipated growth and further population migration (like Florida), there is greater confidence in real estate values holding in the long term, so a sense of urgency to own has not waned if someone is not yet a market player, and this is a potential avenue to achieve this.”

Some Say, Not a Big Appetite for ARMs

Esther Phillips, senior vice president and director of sales at Key Mortgage Services, tells GlobeSt.com that with the inverted yield curve right now there is not much investor appetite for ARMs, meaning there is not a lot of interest in mortgage-backed securities made up with ARM loans.

“And, if there’s no investor demand, the price isn’t there,” Phillips said.

“Where we’re seeing ARMS is in the jumbo or non-conforming loan amounts, as most of these loans are not made with the intention of packaging them up and selling them into the market.”

She said that most are made by banks who are looking to keep them on their balance sheet and, therefore, can set their own price of what they want to yield on it.

“We see banks of all sizes come in and out of the ARM market until they get the needed amount for their balance sheets and then they raise the rates to stop the flow,” Phillips said. “So, it’s much more unpredictable.

“However, if the availability is there and the consumer is educated on the timing, the risks and potential upside of an ARM adjustment it can be a great alternative to a fixed rate in this type of rate environment.

“The key is understanding the risks versus rewards and that’s what a professional loan officer would do to help the consumer make the best decision based on their profile, needs and risk appetite.”

ARM Programs Differ from During Financial Crisis

ARM loan programs today look much different than they did in the 2008 financial crisis, Ross said.

“They are written differently to ensure borrowers can afford increases,” she said. “ARMs are now better regulated with adjustment caps, lifetime caps, and are underwritten to ensure that the borrower can afford an upward fluctuation in payment.

“We learned that Payment Option ARMs with negative amortization features are not a great idea, and I would generally advise against them.

“It is important to note that ARMs are not for everyone, and the gamble is that interest rates could be just as high in five years. A more conservative home buyer or someone who does not foresee being in a position to want to move or face having to refinance in five years would be less suited for an ARM.

“Conversely, a financially stable younger borrower likely to increase their income in the coming years would be in a better position to take advantage of an ARM. Lenders have a responsibility to guide borrowers to the most appropriate loan program.”

Mortgage Rates to ‘Peak’ at Around 9%

Erin Sykes, real estate advisor, Nest Seekers International Chief Economist, tells GlobeSt.com that she is starting to see mortgage brokers talk about ARM mortgages again.

“The way ARMs are structured, they can be typically risky for the average homebuyer, especially when entering a time of economic uncertainty,” Sykes said.

“For those who understand the risks, however, and intend to spend a relatively short period in their home, it could be a viable opportunity.

“I believe rates will peak around 9% for the 30-year, and if so, there is not as much risk going into an ARM near the peak rate, as long as there is a fully understanding about the variability of rates after the introductory period.”

Also Consider Buy-Down Loans

Bob Griffith, general manager of home services at Houwzer, tells GlobeSt.com that another popular option right now is buy-down loans, where the seller can contribute money at closing to reduce the buyer’s interest rate down by 2 percentage points in year one, and one percentage point in year two.