Minyan Mailbag: More on ARMs
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next column with that very intent.
Prof. Succo -
I agree with you regarding your earlier comments about ARM's.
I'm in the mortgage business now, and I've sold life insurance and annuities. I was terrible at selling insurance products, because I knew that variable life and annuities rarely made sense.
ARMs and Interest Only mortgages are only appropriate for very disciplined borrowers who plan to overpay and to pay down the principal. (In an interest only mortgage, the payment is recast based on the principal balance. In a regular amortized ARM, the payment is
set no matter how much you pay toward principal.) Or if the borrowers are more certain they're not going to stay in the house. They just moved to a town for a new job, and likely will be transferred in a few years or will trade up when they have a bigger family. In those scenarios, why get a 30-year fixed.
In Minyan D's example, even if his arbitrage % is correct, the arbitrage goes away once the ARM adjusts. And the annuity has surrender charges. You can't get out of the annuity without costs. And he assumes the house will appreciate.
There are so many current borrowers who do not realize that rates are at 40 year lows. Those ARMs are linked to the Libor or MTA (12 month Treasury Moving average.) They don't look to see where those indexes were in the 1990s or even 2000.
A lot of lenders are now marketing cash-flow ARMs, where the initial payments are artificially fixed at 1.95% or some other low rate. The true underlying rate is immediately adjustable and is tied to the Libor or MTA. And the loan could negatively amortize because the artificially low rate/payment will not cover true interest. The borrowers are given 4 payment options each month: the artificially low rate, the interest only payment, a 30-year fixed payment based on the true rate, and a 15-year fixed payment based on the true rate. The pitch is that people are given payment options based on their cash flow.
People want to buy houses that they can't afford, and lenders are willing to lend.
- Minyan H
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