Sunday, November 14, 2004

Thanks to ARMs, mortgage holders are in double trouble

By Danielle DiMartino / The Dallas Morning News

Double. That's basically what interest rates were in November 1994 vs. today. That was also the last time Americans were taking out adjustable-rate mortgages at today's record pace.

Back then, when the 10-year Treasury yield was about 8 percent, ARMs made sense. At today's 4-percent level, such a choice is plain disturbing.

The Mortgage Bankers Association reported last week that the percentage of new loans being written with adjustable rates hit 35.3 percent in the week ended Nov. 5, matching the 1994 record.

And this in the same week that purchasing slowed and borrowing rates rose. I'm just thinking out loud here, but this may not be one of those records we'd want to cheer about.

SMR Research in New Jersey specializes in consumer finance research. What better group to weigh in on this troubling trend?

"People usually turn to ARMs when rates spike so they can save some money," said George Yacik, vice president of SMR. "Today, people are buying the most possible home, with the lowest payment available, at the prodding of their mortgage broker."

Many of these people are stretching themselves beyond reason, he said, and will run into serious problems down the road.

"ARMs let people borrow extraordinary amounts of money compared to their incomes," Mr. Yacik added.

It's not as if the history of mortgage rates is shrouded in mystery. We know that last year, you could get a mortgage with an interest rate about a half-percent lower than today. And we know that at this time last year, the Federal Reserve had not raised interest rates four times and all but explicitly stated that it had every intention of hiking again.

(I know, I know – mortgage rates don't move in lockstep with Fed action. They march to the beat of the 10-year Treasury. Even so, they're up by half of what the Fed has risen and look to be going higher as the dollar heads south.)

Try as I might, I cannot grasp the concept of consciously taking on a payment you know is going to rise. Maybe I just don't get it. Maybe I'm behind the times.

Mr. Yacik cites ingenuity in the mortgage industry as the reason ARM volume is perversely rising in the face of rising rates.

"A lot of the reason is lenders are trying to keep up their loan volumes," he said. "That means getting as many people qualified to buy as much home as they possibly can."

Problem is, many of these new-fangled loans have yet to be tested outside some number cruncher's office. I'm sure there are sensitivity analyses out there attesting to the soundness of an interest-only, no-down-payment, adjustable-rate with a why-pay-PMI-when-you-don't-have-to piggyback-on-the-side loan.

In fact, no study can correctly predict the Armageddon scenario I fear.

And why is that? Inflation-adjusted home price appreciation the likes of which we're experiencing in the current real estate cycle has never been documented. Not in the 1980s. Not in the 1920s. Not ever.

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