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From Mortgage News Daily.

There continues to be a debate about whether or not 30-year fixed rate mortgages are a good idea. The MBA's president, Dave Stevens, weighed in on the argument last week.

[quote] On the one hand, it could be argued that the fully pre-payable 30 year fixed rate loan was not a necessity in looking back historically. There's some truth to that; to be clear, mortgage interest rates have been on a steady decline for over three decades since their peak in 1980. While clearly homeowner preference for the 30 year mortgage has been high, borrowers would have clearly benefited from an adjustable rate product that would have adjusted naturally downward over the past three decades.

In hindsight, borrowers would have avoided all of the expense and time associated with refinancing as mortgage interest rates essentially dropped from their peak of 18% down to about 3.5% at bottom a few short weeks ago. [Actually, bottom was 2.75 a couple of months ago.] Yes, there were a few spikes along the way, but these were very short lived and would have been more than offset by the eventual rate declines that followed these infrequent corrections. So yes, to those who argue this point, they're correct--in hindsight. And hindsight is always perfect."

The concern I have is the effect of a mortgage market absent the 30 year fixed rate on a forward looking basis where almost absolute certainty calls for interest rate increases. Let's think about a few variables associated with this climate we currently face.

1. The Spike - Hybrid Arms have a built-in adjustment period where the borrower has to face an interest rate adjustment. We know that the future won't be anything like the past; that there's little hope for further rate declines. After all, you can't go below zero. The planning of the rate change at the first adjustment in an ARM can be modeled by risk managers. The "spike" is something that ARM investors have long modeled as they had to plan for prepayments, either from default rates or wealthy borrowers who would pay off their loan. The question is how does a senior citizen on a fixed income deal with a spike? If a 5 year ARM was at 3.5% on a $300,000 loan and rates rise 2%, their payment would climb $350 per month. On a fixed income, this could cause defaults to those individuals. The point is non-fixed rate mortgages pose significant default risks to borrowers in a rising rate scenario. We just haven't experienced that--yet."

2. Compensating factors - One thing we know is that the largest segment of homeownership demand over the next decade will come from first time buyers. Borrowers will have low down-payments. Layering risks of low down-payment mortgages combined with a shorter term mortgage that will have a spike leaves little cushion for the borrower. I'm not passing judgment here on whether lower homeownership rates are good or bad, but the impact to homeownership rates could be implicated as a result of the higher risk of these combined effects.

3. TBA - The 30 year fixed rate predominance is largely the result of the ability of the GSE's (Freddie and Fannie) and GNMA [Government National Mortgage Association bonds, issuers of FHA insured loans] to make a market, hedge basis risk going forward, and drive enough liquidity to provide this nation with the 30 year mortgage. In the United Kingdom, as a comparison, there is no 30 year mortgage. The vast majority of mortgages are 5 year balloon loans that require larger down-payments. "Generation Rent" is the outcry in England as the homeownership rate has been dropping and access has become a huge concern. Those that would completely eliminate government support for housing should look at the UK as a model for what the market in the US could look like.

4. Private Sector Role - One thing we've learned in history is that the banking industry isn't good at long rate mortgages. Lending long and borrowing short has created enormous issues for the banking sector, once having been the fuel for the savings and loan crisis of a few decades ago that cost the taxpayer hundreds of billions of dollars in bailout funds. We shouldn't expect to see a viable, functioning 30 year market without some formal support.

I'm not advocating to keep Fannie and Freddie in their current state. I've spent a lot of time working with others on ideas to transition them and yet consider the need for liquidity in the mortgage markets. I'm saying that I don't think anyone can forecast how important the fixed rate mortgage will be in the years ahead as rates move in the opposite direction from where they came and perhaps expose our nation's housing market and millions of Americans to a very serious set of challenges that could have their own systemic impacts. Getting this right, in a balanced way, will be critically important as we move forward. [quote]
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With interest rates at historic lows, it is hard to argue they will go much lower. Hence, getting a 30 yr fixed rate mortgage sounds like a no brainer. You lock in that rate for a long time.

Of course lenders would much prefer to give you an ARM, because they have every reason to believe rates will be higher for most of that 30 yr period. They react by raising downpayment and credit score requirements--essentially to cut lending to a minimum while rates are low.

Of course news releases to convince people to consider ARMs as a better deal are part of the game. But I doubt anyone with the smarts to get a decent credit score will buy into that sales pitch.
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Of course news releases to convince people to consider ARMs as a better deal are part of the game. But I doubt anyone with the smarts to get a decent credit score will buy into that sales pitch.

That's not AT ALL what the press release said. Let me help you with your reading comprehension skills--or lack thereof. From the release:

The concern I have is the effect of a mortgage market absent the 30 year fixed rate on a forward looking basis where almost absolute certainty calls for interest rate increases. [...] I'm saying that I don't think anyone can forecast how important the fixed rate mortgage will be in the years ahead as rates move in the opposite direction from where they came and perhaps expose our nation's housing market and millions of Americans to a very serious set of challenges that could have their own systemic impacts. Getting this right, in a balanced way, will be critically important as we move forward.
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They react by raising downpayment and credit score requirements--essentially to cut lending to a minimum while rates are low.

Actually, lenders have been gradually relaxing their sphincters over the past 3-6 months... Minimum credit scores for the best programs have been dropping from 720 to 700, and now 680. HELOCs have been extended out from 70% CLTV back to 90% (and even 100% in high income cases.) Reserves requirements have been declining somewhat.

I'm not sure it will ever reach the ludicrous 'fog>mirror' status of 7-8 years ago (in fact, I doubt it will in our lifetimes,) but its certainly getting easier than it had been as recently as 2-5 years ago.

Dave Donhoff
Leverage Planner

P.S. Cath... chill... Paul didn't spit at you ;~)
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With interest rates at historic lows, it is hard to argue they will go much lower. Hence, getting a 30 yr fixed rate mortgage sounds like a no brainer. You lock in that rate for a long time.

Of course lenders would much prefer to give you an ARM, because they have every reason to believe rates will be higher for most of that 30 yr period. They react by raising downpayment and credit score requirements--essentially to cut lending to a minimum while rates are low.

Of course news releases to convince people to consider ARMs as a better deal are part of the game. But I doubt anyone with the smarts to get a decent credit score will buy into that sales pitch.



I do agree it's a no brainer product as it's absolutely the best mortgage option for those who wish to exert zero brain power on making a product decision.

Others can decide what's best for them based on their circumstances.

If I had a nickel for every friend/client/colleague who insisted that they must have a 30 yr FRM and that they would hold that loan for at least 12 years (which is about how long you need to hold it to make it the best option vs. a 10/1) and then refinanced or paid off that loan within 7 years, I'd be a very rich man.
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wasmick: "If I had a nickel for every friend/client/colleague who insisted that they must have a 30 yr FRM and that they would hold that loan for at least 12 years (which is about how long you need to hold it to make it the best option vs. a 10/1) and then refinanced or paid off that loan within 7 years, I'd be a very rich man."

Who routinely offers 10/1's? I usually see 5/1 or once in awhile, 7/1.

And does recovery period not depend upon the initial lock time, the spread between the fixed rate and variable rate at the time of locking/closing the loan, and the caps applicable to the variable rate loan?

Regards, JAFO
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Who routinely offers 10/1's? I usually see 5/1 or once in awhile, 7/1.

They're a center of the plate ordinary offering here in the NY metro area, as is the 7/1.


And does recovery period not depend upon the initial lock time, the spread between the fixed rate and variable rate at the time of locking/closing the loan, and the caps applicable to the variable rate loan?

Of course.

In general right now the 10/1 is running about .375% to .50% below the 30yr.

My point was and is that behavior often trumps logic when making these choices. Don't get me wrong, I think the 30yr has its place and is a great choice for someone who actually may be in their home and keep their loan for a very long time. But the idea that that is most of the people most of the time or that Fixed/Adjustable rate loans are some evil instrument of the devil created by banks to screw innocent borrowers is brainless, populist crap.
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But the idea that that is most of the people most of the time or that Fixed/Adjustable rate loans are some evil instrument of the devil created by banks to screw innocent borrowers is brainless, populist crap.

The only people who say that are ARM proponents who claim that ARM opponents are saying that.


Don't get me wrong, I think the 30yr has its place and is a great choice for someone who actually may be in their home and keep their loan for a very long time.

It's all about controlling your risk. A 30yr FRM rate and payment stays the same for 30 years. No matter what, you never have to pay more.

AFAIK, the 5/1 is the most popular ARM. With 2/5 caps, you rate could almost double in years 6 & 7, and the top possible rate is more than double the initial rate. You can poo-poo the risk of that happening, but it is a real risk. You can define it away by claiming that you'll sell before the rate goes up -- but defining it away doesn't mean that the risk goes away, you are just shutting your eyes to it.

Thing I find funny is that (some of) the same people who are blithely willing to accept that risk are deathly afraid of taking any risk in other investments and invest in something like an IUL because that has "no risk of ever losing any money in any month ever". (Looking at you, CCinOC)

Pay a large opportunity cost by getting an IUL, for "safety" -- yet borrowing money with an ARM which can more than double your payment, for "saving a few dollars in interest"?? Doesn't make sense. Not consistent.

Especially since we *know* that ARM rates will be going up, because the Fed won't keep rates at near zero for much longer.
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Past performance is not a guarantee of future performance. With 30 year fixed rates in the 3%, I doubt we'll see the same decrease in mortgage interest rates over the next 3 decades as we did the past 3 decades.
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The only people who say that are ARM proponents who claim that ARM opponents are saying that.

I don't agree with that. I do think that for folks who do not understand how to manage their risk or for folks who are very risk averse a FRM is the best choice.


It's all about controlling your risk. A 30yr FRM rate and payment stays the same for 30 years. No matter what, you never have to pay more.

I agree.

It's the right product for folks who think like this. It's not a question of wrong or right, the loan that allows one to sleep at night is the right loan product for that individual.
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JAFO,

I don't know about 10/1 ARMs, but I think AIMLoan often has them.

DW & I will be in our home until 2020 by which time we'll both be 66 and ready to move. Last year we did an interest-only ARM with AIM. It's at a ten-year fixed rate (two and seven-eighths, for about a point or so) which converts to an ARM for the last twenty years (by which time we'll be gone). As you can guess, it slashed out payments to the point where they are less than our property taxes and we use the savings to bolster our retirement savings.

As an aside, AIM was a royal pain to deal with and our loan person was so incompetent we finally had to get a supervisor involved. Apparently something was messed up at our closing and they - without telling us - never actually went through with the loan even though we did a closing. We then had to "re-close" a month later after they got everything straightened out. (They tried to soak us for some additional fees, but I raised hell and they finally credited the amount back to us.)

I would only recommend AIM to folks who are diligent and patient. They are not for the weak of heart.
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I should also add that we have excellent credit scores and about 50% equity in our home. That helped us qualify for best rates.
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