Adjustable-rate mortgages, one of the main culprits of the housing crisis, are coming back into vogue. But the banks say this time it’s different.
Financial groups are softening the conditions to encourage customers to take out these loans, called ARMs, whose rates can jump after a few years. Some ARMs are cheaper, relative to fixed rate mortgages, than they have been in over a decade.
The tactics recall the run-up to the 2008 crisis, when ARMs exploded in popularity as banks and mortgage brokers touted their low initial rates to consumers.
Now, however, financial leaders say they are focusing on borrowers with strong credit who are using the loans to take out big “jumbo” mortgages – not so-called subprime borrowers, who have used the loans to extend their purchasing power as far as possible. could go.
ARMs accounted for 31% of mortgages in the $417,001 to $1 million range issued during the fourth quarter of 2013, according to data prepared for The Wall Street Journal by Black Knight Financial Services, formerly Lender Processing Services, a mortgage data company and service company. This represents an increase from 22% the previous year and the highest proportion since the third quarter of 2008.
Of mortgages over $1 million, 61% were ARMs, up from 56% a year earlier.
“We are seeing a return to ARMs,” says Mike McPartland, head of investment finance for North America at Citi Private Bank, a unit of
“My opinion is that it will continue.”
Banks are betting that rates will rise enough to offset any interest they waive in the first few years. Borrowers are betting that rates will stay relatively low or that they will sell their homes before their interest rates adjust higher.
Last month, Richard Herrmann of Fairfax County, Va., refinanced a 30-year fixed rate mortgage with a rate of 4.875% to an ARM with a fixed interest rate of 2.875% for the first five years. The loan rate resets every five years. Mr. Herrmann, a 59-year-old engineer for the US military, and his wife plan to sell their home in 10 years, so they expect only one rate reset.
“It’s still a crapshoot with an ARM,” Mr. Herrmann said. “It seemed like the best compromise.”
While lenders this time say they are enforcing strict lending guidelines and focusing on higher-rated borrowers, there are signs they are expanding the pool of eligible customers.
Some smaller lenders, such as credit unions, target retirees and other borrowers looking for extremely low rates. And banks are increasingly offering interest-only ARMs, which require customers to pay interest only for 10 years, and which were among the loans that caused problems for subprime borrowers during the crisis.
Bank of America Corp.
and Citigroup say they originated more interest-only mortgages in the past year through their wealth management and private banking divisions.
The loans were last popular during the housing bubble and have been seen as a cause of many foreclosures, although banks say they only approve borrowers with excellent credit who can pay principal and interest on these loans.
Citi Private Bank says about half of the RMAs it originates are interest-only, and the
The wealth management group says most clients who sign up for ARMs receive the interest-only feature.
Mortgage issuance fell across the sector, following a drop in refinancing activity after interest rates started to rise last year.
“It’s only natural in this part of the cycle…for banks to start rethinking their conservatism,” said Todd Hagerman, analyst at brokerage firm Sterne, Agee & Leach Inc. “There are ways to relax lending standards to generate more growth while keeping a tight enough restraint that the risk profile of the business does not change overnight.”
Many banks hold ARMs on their books rather than selling them to government-backed finance companies, as they often do with more conventional mortgages. This means that when loan rates are finally reset, they can reap the benefits of higher interest payments from borrowers.
ARMs accounted for 37.1% of mortgages held on banks’ books in the fourth quarter of 2013, down from 35.8% in the same period a year earlier and 31.9% two years earlier, according to Inside Mortgage Finance. , a specialized publication. This is the largest share since 2009.
The surge in ARMs comes seven years into the housing crisis, when rising payments left borrowers at risk of falling behind on their loans or losing their homes. Between 22% and 25% of subprime ARMs were in foreclosure each quarter from early 2009 through 2011, according to the Mortgage Bankers Association.
Subprime borrowers have traditionally been defined as those with credit scores below 620.
The easing of lending standards – which included lending to subprime borrowers and the sale of riskier products such as ARMs – was a major cause of the financial crisis. When the US economy crashed in early 2008, many homeowners with ARMs saw their home values drop as their payments rose.
The profile of an average ARM borrower has changed significantly since then. The average credit score of borrowers who took out ARMs in the fourth quarter of 2013 was 762, down from 693 in the same period of 2006, according to Black Knight Financial.
Banks “provide these loans primarily to high-net-worth borrowers, which significantly reduces risk,” said Stuart Feldstein, president of SMR Research Corp., a mortgage research firm in Hackettstown, NJ.
Certain types of risky loans have largely disappeared, such as so-called option ARMs, which allowed borrowers to make small monthly payments that could lead to an increase in the loan balance.
The average rate on a jumbo ARM type was 2.91% for the week ending March 7, about 1.5 percentage points lower than the 30-year fixed-rate jumbo, according to the mortgage information website HSH.com. This difference, which has been maintained mainly since November, is the largest since 2003.
The rates of some of the most popular ARMs can increase by a maximum of six percentage points after the end of the fixed rate period, depending on the increase in their reference rate.
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