Interest-only and hybrid-ARM products are flooding the market -- but for the proper borrowers?

William J. Lopez, director of mortgage banking, Wholesale Lending Online

As published in Scotsman Guide's Residential Edition, September 2005.

All loan products fall into one of two categories: mortgages with fixed rates or mortgages whose rates change during the life of a loan. With options such as hybrid and interest-only loans, however, the marketplace is more complex.

Similar to other adjustable-rate mortgages, hybrid ARMs have a payout period of 30 years with an interest rate that adjusts periodically. With a hybrid loan, the first rate adjustment is delayed from between one and 10 years, after which the rate adjusts annually.

As consumers drive much of the demand in the market, many products and services correlate directly to rising interest rates and the increasing cost differential between standard, fixed mortgages and ARMs. Although decreasing rates and slow economic growth play large roles in ARMs’ popularity and staying power, the market is seeing new ARM loans, including the interest-only and hybrid-ARM products. The debate centers on whether credit standards are falling too far as well as on these loans’ potential for trouble. But the bigger question is whether the right borrowers are sold the appropriate products based on their incomes and circumstances.

Considering the past and future
The popularity of adjustable-rate mortgages is not new. In the 1980s, ARMs comprised more than 50 percent of all loans. But there was one big difference: Short-term rates then were considerably less than those for fixed mortgages. Today, buyers are grabbing lower ARM rates that can require a much higher payment within a year. In some cases, borrowers are simply looking for the lowest payment now without considering what their payments will be in the next few years. These borrowers could face disastrous ramifications that lead to default and foreclosure.

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