As published in Scotsman Guide's Residential Edition, December 2005.
The monthly ARM, or option ARM, is a mortgage product that was designed to provide borrowers with multiple payment options and flexibility. During the past few months, though, the adjustable-rate mortgage has drawn increased scrutiny and cautionary press. Once offered by a limited number of portfolio lenders, it is now a product widely delivered into the secondary market.
As a result, ratings agencies, regulators and other pundits have taken exception to certain characteristics of the monthly ARM. Elements of these mortgages have caused them great concern about the potentially negative impact they might have in an increasing-rate environment.
Some concerns are valid, but the real issue isn't with the product itself. Rather, it is with the way the product has been marketed and delivered to borrowers who may not need this type of loan.
Causes for concern
In the past year or so, the monthly ARM has grown to become a significant percentage of total mortgage originations. According to a Bear Stearns report from July 2005, ARMs comprised 43 percent of mortgage issuances in 2004, while the Mortgage Bankers Association said that 46 percent of new mortgages in 2004 were ARMs -- up from 29 percent in 2003.
In the early 1980s, regulatory limitations on mortgages were lifted, and the ongoing high-interest-rate environment caused ARMs to become a vehicle for home affordability. The original concept, in part, was that these products would help keep the housing market afloat by offering alternatives to consumers needing budget help for homeownership.
Today, there are many types of enhanced structures, such as interest-only products as well as this highly scrutinized monthly ARM, which are designed to provide borrowers with options and affordability. They are not, however, meant to be a last resort for borrowers who have struggled with their debt and are attempting to "save the farm." These borrowers likely will end up with a product that they do not wholly understand -- aside from the fact that it will bring them temporary relief. In some of these situations, relief can turn into payment shock sooner or later.
When this scenario occurs, consider asking the following questions:
Did the borrowers, consumed by the possibility of monthly payment reduction, fall into a false sense of security? Did they possibly forget that if something seems too good to be true, it often is?
Did the loan originators, more concerned with their own income, present all product details, such as potential deferred interest and rising balance and the potential payment recast?
Did the originators simply show the borrowers the payment rate and payment comparison and assure them all would be well?
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