Q. A few weeks ago I read one of your columns about adjustable-rate mortgages. Coincidently, I recently noticed my credit union has fliers in my branch offering a 5/1 ARM at 4 percent.
Have we not learned one single thing from the credit crisis? ARMs should be banned. Why would someone like you who writes a column suggest that an ARM is a good thing?
A. Well, maybe because an ARM is, indeed, a good thing in certain circumstances. Banning adjustable-rate mortgages strikes me as a bit excessive. Should we ban cars because people are killed in car accidents? Or medicine because some people abuse it? Come on, now.
The credit crisis was not caused by ARMs. It was caused by a “perfect storm” of events that could have and should have been foreseen. Here’s a summary:
Both the Clinton and Bush administrations encouraged homeownership without any plan to deal with the possibility that property values might someday fall. This encouragement, coupled with rising property values, spurred mortgage giants Fannie Mae and Freddie Mac to relax their underwriting guidelines, offer zero-down financing and dabble in the subprime market through so-called “Alt-A” programs.
Wall Street got into the game by promising to purchase more exotic loan programs from banks. These programs included ARMs with negative amortization (which allows a borrower to make a payment that’s less than the interest owed) and high-yield subprime loans (which carried very high rates and were offered to folks with lousy credit).
Mortgage brokers jumped into the game by selling the products that the federal government, Wall Street, and Fannie and Freddie gladly purchased.
The freight train steamed ahead to its inevitable crash.
I’m not sure where it came from, but one of my favorite sayings is: “The price of freedom is responsibility.” Instead of outlawing adjustable-rate mortgages, they should be taken out by the folks whose particular situation is most suitable to an ARM.
It’s no wonder your credit union is offering ARMs. They are a good deal for a lot of people right now. Here’s a sampling of good ARM candidates:
• A property owner who plans on selling his home within five or seven years can refinance to a low rate that’s fixed for the same period. If the loan will be paid before the rate adjusts, the homeowner bears no interest-rate risk.
• A homebuyer who has good job stability and the probability for increased income. These folks are typically professional, first-time homebuyers with excellent credit who want to keep their payments low for the first few years.
• Many wealthy homeowners choose ARMs when the rate is so low that it makes sense, for tax purposes, to hold a mortgage rather than own a home that’s free and clear.
So let’s not throw the baby out with the bath water. Lenders offering ARMs these days require that the borrowers have excellent credit, good savings and strong income.
Having a choice is a good thing. It’s up to the individual to choose wisely.
Henry Savage is president of PMC Mortgage in Alexandria, Va. Reach him at henrysavage@pmcmortgage.com.
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