Trouble With Adjustable Rate Mortgage Resets
Despite lower rates, fundamental problems persist.
There's a detailed set of slides breaking down the woes in the housing market out from Real Estate Consulting. Although it's interesting, a couple back-to-back slides from that presentation appear to be off the mark.
Click to enlarge either slide
The first chart states "ARM loans made in 2004-2006 will create huge reset problems in 2007-2009". The second chart specifically points out loans made in 2005-2006.
Let's start with a discussion of Adjustable Rate Mortgages (ARMs). ARMs are based on an index rate, typically 1-year treasuries or 1-year LIBOR, plus a margin amount (e.g. the treasury rate + 2.75%) .
The interest rate's fixed for an initial period (three years for a 3-1 ARM, 5 years for a 5-1 ARM, etc.) but then floats with the index, adjusted periodically (typically yearly).
The margin amount varies lender to lender and it doesn't change when a loan resets.
With that background, here are charts and tables of treasury rates and LIBOR for the last ten years. We'll use the rate tables to see what's likely to happen when mortgages reset.
One Year Treasury Rates
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One Year Treasuries Table
One Year LIBOR Table
(The previous three charts courtesy of Money Cafe.)
An important word about the above tables:
Initial rates on any given day may be based on factors other than the index rate at that time. In cases where lenders were aggressive, initial rates may have been lower than implied above, creating more of a reset problem down the road. In cases where lenders were more cautious, initial rates may be slightly higher than implied, creating a more beneficial situation when rates reset.
Specific circumstances vary day by day and lender to lender. Thus, the above tables are best used as a guideline as to what took place, as opposed to an absolute mathematical reference point.
Current Quotes as of March 29
1 Year Treasuries - 1.56
1 Year LIBOR - 2.52
3-1 ARMs Analysis
Based on the above table, 3-1 treasury based ARMs initiated in 2005-2006 would likely reset lower. I stress likely because initial rates on any given day may be based on the above caveat on day to day conditions, lender specific conditions, etc.
3-1 LIBOR based ARMs initiated in 2005-2006 would also likely reset lower and again with the same caveat repeated about day-to-day conditions, lender specific conditions, etc.
In general, loans originated in 2005-2006 simply don't appear to be a problem. In fact, the reset of 3-1 ARMs from those years may provide economic stimulus. This statement may not apply in every case but it should be true for many, if not most, cases.
3-1 ARMs prior to 2005 have already reset. So those problems, whatever they were, have already been faced.
5-1 ARMs Analysis
5-1 ARMs analysis is more difficult. However, we can say that the above charts clearly show that loans originated in 2003-2004 are more likely to be problematic than loans originated in 2005-2006.
Here's an analysis from my Certified Mortgage Planning Specialist friend:
"Most of the 5/1 ARM's I reviewed that originated in 2003 had start rates between 4% and 5.125%. This makes it hard to lump them all together to state they will in aggregate reset higher or lower. Some of this will depend on points paid to reduce the original interest rate. Many of these loans will reset marginally higher than they were before. However, the situation is far better now than it was even a few short months ago where it appeared virtually every loan in this group would reset much higher."
While likely to be net negative to the borrower, 5-1 ARM adjustments from 2003-2004 are not likely to be the end of the world. Some may even benefit. Looking ahead, adjustments on 5-1 ARMs for 2005-2006 are likely to be consumer friendly, based on the above tables.
However, 5-1 ARMs from 2005-2006 won't reset until 2010-2011. Those loans are simply not today's problem.
Principal Payments Needs To Be Factored In
There's still one more issue to address, and that is higher payments when the interest-only period ends. For example, a 5-year ARM loan typically goes from interest only payments to interest + principal amortized over 25 years on the first rate reset. Likewise a 3-year ARM loan typically goes from interest only payments to interest + principal amortized over 27 years on the first rate reset. Some ARMs have a 10 year interest only period which postpones this particular problem.
Many of those in 3-Year ARMs with principal and interest payments will see their total mortgage payment drop. This is especially likely for loans originated in July of 2005 or later. However, those paying interest only for three years may see their total payments rise.
For others, especially those in 5-year ARMs, there could be payment shock even if the interest rate drops. Once again, it will be the 2003-2004 loans that will prove to be more problematic.
Where Is The Reset Problem?
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