June 20th, 2011 1:16 PM by Dan Marchiando
Adjustable-Rate Mortgage (ARM) Improvement Continues
Adjustable-rate mortgages (ARMs) are continuing to improve, and the offered interest rates are now attractive again. Actually, some of these ARM loans never really went away. When lenders and investors don’t want to make ARM loans, they don’t take them off the menu so-to-speak, they just price them unattractively compared to their 30-year fixed-rate loans.
So what has changed?
1) The interest rate savings, between ARM loans and traditional 30-year fixed rate loans has increased most recently, making ARM loans worth considering , depending on the personal circumstances of the borrower. So a 30-year fixed-rate loan might have an interest rate of say 4.50%, while a 7-year ARM loan might be available for under 3%; enough of a difference to make an ARM worth looking at.
2) All the more exotic, confusing and complex ARM loans, like negative-amortizing “Option ARMs”, “PayOption ARMs”, “Pick-a-Pay”, NegAm, “Flex-Pay”, plus all the short-fused subprime ARMs are now gone from the market, as the lenders (i.e. WAMU, World, and Countrywide) who marketed them have all disappeared.
3) Almost all the currently available ARM loans are based on a single interest rate index, namely the one-year LIBOR index. Indexes like COFI, COSI, CODI, CMT, 1-Year Treasury, T-Bill, and MTA have all but disappeared from use. While there are still legions of existing ARM loans in place that are based on these rate indexes, new ARM loans based on these indexes are not being offered. Home Equity Lines of Credit(HELOCs) continue to be offered based on the Prime Rate index.
4) The “interest-only” feature for ARM loans is less commonly seen, but is still available. In past decades, as ARM loans evolved, the interest-only feature ended up being included with most ARM loans, and the interest rate on Interest-Only ARMs were often the same as for loans without the interest-only feature. Today most lenders price their Interest-Only ARM loans with slightly higher interest rates than they do their regular or fully-amortizing ARMs. This slightly higher interest rate takes away some of the lower payment advantage that the interest-only payment has over the fully-amortizing, principal and interest payment of the more plain-Jane ARM loan.
5) As recently as about 2008 or 2009, lenders were qualifying borrowers—or determining their ability to repay loans—based on the lower monthly interest-only payment. To put this in perspective, a $400,000 7/1 interest-only ARM at 4% would have a monthly payment of $1,333. But a fully-amortizing loan at the same 4% interest rate would have an initial monthly payment of $1910. So when crunching the debt-to-income ratio of a borrower, they would use the lower initial interest-only payment to qualify. On interest-only loans in 2011, lenders are using the higher fully-amortizing monthly payment to compute debt ratios and qualify borrowers, even though the loan allows the borrower to pay less for the first few years of the loan. The affect is that interest-only loans no longer make it easier to qualify borrowers for larger loan amounts.
Thanks for your interest,