By Mitchell D. Weiss
It was only a matter of time.
Adjustable-rate mortgages--the apocalyptical financial product of the recent economic collapse--are coming back in a big way. Of course, the banks insist that this time it'll be different. At the moment, they're targeting only high-net worth borrowers. According to a study that was developed for the Wall Street Journal, during the fourth quarter of 2013, roughly one-third of mortgages that ranged between $400,000 and $1 million, and nearly two-thirds of those over $1 million, were adjustable-rate mortgages.
But U.S. banks are under earnings pressure these days. Profit margins are shrinking, in part because demand for loans--mortgages in particular--has fallen off as interest rates have begun to rise and the economic recovery remains uncertain. Consequently, it's reasonable to anticipate that lenders will once again rationalize their way to broadening the scope of their marketing efforts by relaxing credit underwriting standards. It also helps that ARMs end up shifting to borrowers the interest rate risk the lenders would otherwise have to take with fixed-rate loans.
When interest rates are stable and low--as they've been these past few years--conventional loans rule. But when the economy starts to crank and rates begin to move, which is beginning to happen now, adjustable loans can become awfully tempting for both borrowers and lenders. The hook is a low monthly payment to start--often, meaningfully lower than for a fixed-rate loan. Later on, of course, you're playing with fire.The issue is how much heat can you stand? Start by asking yourself these questions:
- How much room do I have in my budget for a bigger monthly payment in the event that interest rates move up?
- What if credit becomes tighter or if interest rates move up so much that I can't refinance my way out of the loan?
- What if I can't sell my house for a price that's high enough to pay off the debt I have against it?
Suppose you were in the market for a 30-year, $200,000 mortgage. Let's also suppose that you have several options including two that look like these:
A 4.5% fixed-rate mortgage. Your interest rate will stay at 4.5% (a $1,013.37 monthly payment on the $200,000 borrowed) for however long you decide to keep that mortgage.
A 3/1 adjustable-rate mortgage with a 2/2/6 CAP. Your interest rate will start at 3% (a $843.21 monthly payment on the $200,000) during a three-year introductory period. Afterward, the rate can adjust by up to 2 percentage points each year with a lifetime adjustment cap of 6 percentage points. That means if interest rates were to go crazy, your initial 3% rate could go to 5% after the first adjustment, 7% after the second adjustment and top out at 9% after the third.
That's a whole lot of interest rates. I'll put them into a table (courtesy of Bankrate.com's ARM calculator) so that you can see what could happen to your monthly payments:
While the 3% ARM starts at a $170 advantage to the conventional loan, that benefit can turn into a $507 disadvantage as the monthly payments have the potential to almost double over time. That's more than $6,000 of extra interest each year, once the 9% cap is reached!
Although most prefer conventional loans to ARMs--because budgeted loan payments aren't something many consumers like to see change--there are those who don't mind playing with financial fire for other reasons (they expect to sell the house before the first adjustment period comes to pass, for instance). If you're one of them, consider one last bit of advice: Don't be greedy! Interest rates are still unusually low. Is the $100 or $200 payment advantage I described above really worth the downside risk? When rates are at rock bottom, it's all downside risk.
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its affiliates. Mitchell D. Weiss is an experienced financial services industry executive and entrepreneur, adjunct professor of finance at the University of Hartford, a member of the board of the university's Barney School of Business and co-founder of its Center for Personal Financial Responsibility. Mitch is also the author of College Happens: A Practical Handbook for Parents and Students, Life Happens: A Practical Guide to Personal Finance from College to Career-2nd Edition, Life Happens: A Practical Course on Personal Finance from College to Career and Business Happens: A Practical Guide to Entrepreneurial Finance for Small Businesses and Professional Practices.
Building permits/total housing units: 0.15% Decline in building permits 2005-2011: -60.29% (11th smallest) Building permits 2011 YTD: 8,136 Total housing units: 5,567,315 At the beginning of 2011, a number of new, restrictive building codes went into effect in Pennsylvania. This caused a rush among builders to secure permits, with housing permits increasing a massive 117.8% between November and December 2010, according to the Philadelphia Federal Reserve. The state's housing market has not been doing well since. Permits issued from January to June 2011 fell 16% compared to the same six-month period one year earlier. The national average for permits issued in the first six months of 2011 compared to the first six months of 2011 is a decrease of 6%. Read more at 24/7 Wall St.
Building permits/total housing units: 0.14% Decline in building permits 2005-2011: Building permits 2011 YTD: -77.09% (11th largest) Total housing units: 721,830 Maine has seen one of the largest decreases in building permits in the past six years. This is unsurprising as home sales in general declined substantially. Home sales for June 2011 decreased 21.39% from June 2010, according to the Maine Association of Realtors. The state's median sales price also decreased 1.37% over this same period. According to numbers from the Census Bureau, Maine has the highest vacancy rate in the country, reaching 22.8% in 2010. However, this number also includes empty vacation houses. Read more at 24/7 Wall St.
Building permits/total housing units: 0.14% Decline in building permits 2005-2011: -61.85% (12th smallest) Building permits 2011 YTD: 11,033 Total housing units: 8,108,103 New York State's housing market is among the largest in the country. As a result, the number of permits is minuscule when compared to the state's total housing units. Although new home sales decreased in the first half of 2011 from 2010, the number of permits actually increased slightly during that period, from 10,189 in 2010. This is significantly lower than 2005's 28,921 permits. Read more at 24/7 Wall St.
Building permits/total housing units: 0.12% Decline in building permits 2005-2011: 69.55% (24th smallest) Building permits 2011 YTD: 3,402 Total housing units: 2,808,254 Despite having a healthy economy compared to much of the country, Massachusetts' housing market is beginning to face serious troubles. In June 2011, sales of single-family homes in the state decreased 23.5% from the year before, reaching the lowest level since 1991, according to the Warren Group, a New England real estate research firm. With so few home sales, it follows that not many new homes are being built. Year-to-date, building permits for 2011 are about one quarter of what they were in 2005. Read more at 24/7 Wall St.
Building permits/total housing units: 0.12% Decline in building permits 2005-2011: -76.61% (12th largest) Building permits 2011 YTD: 6,184 Total housing units: 5,127,508 Ohio has suffered, and continues to suffer, greatly from the housing crisis. Over 8,000 homes were foreclosed in July 2011, the ninth-largest amount in the country, according to real estate company RealtyTrac. With such a high foreclosure rate, currently at one in every 608 housing units, housing is already too inexpensive for people to want to build. Ohio has therefore had one of the greatest decreases in building permits in the country over the past six years. Median existing home sales are also down in many areas of the state, according to data from the National Association of Realtors. In Toledo, prices are down 17% from one year ago, the third largest rate in the country. Read more at 24/7 Wall St.
Building permits/total housing units: 0.09% Decline in building permits 2005-2011: -74.06% (14th largest) Building permits 2011 YTD: 1,403 Total housing units: 1,487,891 Connecticut has had one of the greatest declines in the number of new building permits in the country. This trend saw a small turnaround in June -- the first monthly year-over-year gain in 2011 in new construction, according to the Connecticut Department of Economic and Community Development. However, the Hartford Courant reports that for "the first six months of the year, residential construction was down 30 percent compared with the same period in 2010." June was also the first increase in home construction in five years. Read more at 24/7 Wall St.
Building permits/total housing units: 0.09 Decline in building permits 2005-2011: -82.19% (7th largest) Building permits 2011 YTD: 4,250 Total housing units: 4,532,233 Michigan is one of the states that has suffered the most from the recession. The state's unemployment rate peaked around 15% in 2010. It is now at 10.5%, which is still significantly higher than the national average of 9.2%. The state has a vacancy rate of just under 15%, which is one of the highest in the country. New building permits have also decreased by over 80% since 2005, also one of the highest rates in the country. The state may now be more focused on tearing down old buildings than building new ones. Read more at 24/7 Wall St.
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Building permits/total housing units: 0.09% Decline in building permits 2005-2011: -72.71% (17th largest) Building permits 2011 YTD: 774 Total housing units: 881,917 West Virginia's decline in building permits has slowed to almost a crawl. In the first six months of 2005 the state issued almost 3,000 permits. For the first half of 2011, that amount decreased to 774. If every permit were to result in a new housing structure, those homes would represent less than 0.1% of the total housing units in the state. Despite all this, construction is one area that is benefiting the state. According to the organization WorkForce West Virginia, 700 construction jobs were added in-state this past July -- the largest amount of jobs added in the private sector. Read more at 24/7 Wall St.
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