Why Modified Mortgages Are Still Risky

Remember adjustable mortgages?

Higher interest rates make these mortgages attractive again for homebuyers, as starting rates are typically lower than traditional fixed rate home loans. But it can be more dangerous.

An adjustable rate mortgage, known as an ARM, can raise or lower interest rates over time. Interest rates are typically lower than the 30-year fixed rate mortgage rate. However, monthly payments are more expensive for borrowers as they can change after a specified period of time, such as 3, 5, or 7 years.

There hasn’t been much demand for ARM in recent years, as both fixed and projected mortgage rates have been kept low. They also gained notoriety in the financial crisis. Unqualified borrowers were initially deceived by the low interest rates and were unable to keep up with the rising payouts.

According to Eric Stein, senior vice president of the Center for Responsible Lending, legislation passed after the financial crisis has made ARM “more secure and transparent than ever before.”

For example, lenders must ensure that borrowers have a reasonable ability to repay their loans, and ARM no longer imposes upfront penalties, so borrowers can easily repay or refinance their loans if they cannot afford higher payments. there is. But he said floating rate loans have inherent risks. “It is up to the borrower to evaluate it.”

But with interest rates and home prices soaring this year, some borrowers are turning back to ARM to make their home payments more affordable.

According to housing finance giant Freddie Mac, the average 30-year fixed loan rate is 5% today from less than 3% a year ago. Meanwhile, the median selling price of a previously owned home was about $391,000 in April, up nearly 15% from the previous year, according to the National Association of Realtors. (And the regular selling price is much higher in some regions.) The combination of higher interest rates and more expensive mortgages means some buyers are feeling the pressure.

“We get a lot of questions and inquiries about ARM,” said Brian Rogge, chief credit officer at online lender LoanDepot. “It’s a very powerful tool to use in terms of value for money.”

Only 4% of mortgage applications last year went to ARM, said Michael Fratantoni, chief economist at the Mortgage Bankers Association. He said the share has risen to about 10% this year, aided by interest rate hikes.

He said, “The borrower who wants to buy now can save a lot of money by choosing ARM.” According to Freddie Mac, the average starting rate for a variable rate loan with an initial fixed rate term of 5 years is 4.04%, compared to 5.09% for a fixed rate loan. This difference means you can save more than $200 per month on a $350,000 loan, at least until you start.

“This is real money.” Dr. said Fratantoni.

Rogge said some borrowers can save money over the term of a loan by using their savings to repay the principal on the loan during periods of low initial interest rates. He said, “If you can afford it, I recommend saving or saving money with the ledger.”

Of course, the important thing is that the price may go up after the fixed price period ends. Mortgage experts say they were able to offer “interesting” low rates and quick reset rates compared to ARM available before the financial crisis, but today’s variable rate loans are much safer. They usually have a flat rate period of at least 3 years and thereafter a limit on how often and how much they can increase their rates (eg no more than 2 percentage points per year). Dangerous automatic weapons that allow borrowers to pay interest on their loans or choose how much they pay for themselves are no longer widely used.

However, the borrower may increase the interest rate after the initial repayment period. So, if you can’t sell your home or refinance your loan, you need to plan ahead so you can pay more. No one can predict what interest rates will look like in five to seven years, but they are rising now.

Martin C., associate professor of personal financial planning at Kansas State University, said, “There’s not a lot of room to go down, but a lot of room to go up.”

It is wise to calculate what you will pay if the interest rate goes up to the maximum loan amount. The Consumer Financial Protection Bureau provides a guide to adjustable mortgage loans to help you evaluate your loan. You can also calculate higher payouts yourself using online tools such as those provided by Freddie Mac.

Because ARM is more complex than traditional mortgages with more terms to understand and potential changes to track, borrowers need time to really understand the terms of the loan.

Linda McCoy, president of the National Association of Mortgage Brokers, said, “Be informed and educated before you jump in there.

Here are some frequently asked questions about adjustable mortgage loans.

What does this mean when ARM is declared 5/1, 7/1 or 10/1?

The first number represents the fixed rate period (5, 7, or 10 years). The second is how often the price can change after a fixed price period (once a year in this example). However, loans with interest rates that change every six months are also common. Commonly cited as 7/6 months, 10/6 months, etc.

Long Island mortgage broker Sean Bloch said some loans allow for larger increases on the first reset (often 5 percentage points above the initial rate) and no more than 2%. He said some lenders guarantee ARM based on the borrower’s ability to pay an initial fixed interest rate plus 2 percentage points.

Most ARMs also set a cap on the total increase over the loan term. So, if the initial fixed interest rate is 4% and the maximum is 5, the interest rate cannot exceed 9%. However, it still results in a much higher monthly payment.

When does ARM make sense?

If you’re sure you’ll be staying in your home for a relatively short period of time, shorter than the term of a fixed rate loan, then ARM may make sense. You can sell your home or refinance your loan before the price resets. People such as medical residents or law students who can realistically expect significant pay increases before being reassigned could also benefit, McCoy said.

However, this option can be very risky, for example, for hourly earners who see floating rate loans as the only way to buy a particular home. “I will not give them ARM” she said. They could lose most of their home and investment if they can’t pay a higher amount.

Ultimately, it’s up to you to take the risk, said Dr. Kansas State’s Dr. said C. “I have low tolerance for risk,” he said. “I will never have an arm arm.”

Can I reset interest on ARM to a lower interest rate?

Yes. After the initial redemption period, the ARM price is based on a benchmark market index and a fixed interest rate called margin. So, a fall in the index may also result in loan interest rates. However, for many loans, the minimum price cannot fall below this. Contact your lender or review the loan disclosure documents to find out what those rates are.