Tag Archives: Access Blueprint

Rates up in ARMs

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AgnosticPreachersKid

Marriner S. Eccles Federal Reserve Board Building

TheStreet.com quoted me in Fed Hike Means Adjustable Rate Mortgages Will Rise and Increase Monthly Payments. It opens,

The first interest rate hike by the Federal Reserve in nearly a decade means consumers can no longer take advantage of a zero interest rate environment. Particularly challenged will be homeowners who have adjustable rates and stand to face higher mortgage payments.

Record low mortgage rates are set to be thing of the past as the Fed raised rates by 0.25%, which appears to be a nominal amount initially. Of course, consumers need to consider the cumulative effect of the central bank’s decision to increase rates periodically over a span of two to three years. The consecutive rate hikes will affect homeowners with adjustable rate mortgages when they reset, which typically happens once a year.

“The initial interest rate move is very modest and consumers will see a corresponding increase in their credit card and home equity line of credit rates within one to two statement cycles,” said Greg McBride, chief financial analyst for Bankrate, the North Palm Beach, Fla. based financial content company. “The significance is in the potential impact of whatever interest rate hikes are put into effect over the next 18 to 24 months.”

The Fed will continue to raise rates several times next year since yesterday’s move is not a “one and done” move, said Robert Johnson, president of The American College of Financial Services in Bryn Mawr, Pa. The Fed will likely follow with a series of three to four rate increases in 2016 if the economy continues to improve. The central bank could raise interest rates to a total of 1.0%, which will cause mortgage rates, auto loans and credit card rates to rise in tandem.

Adjustable rate mortgages, or ARMs, are popular among many younger homeowners, because they typically have lower interest rates than the more common 30-year fixed rate mortgage. Many ARMs are called a 5/1 or 7/1, which means that they are fixed at the introductory interest rate for five or seven years and then readjust every year after that, said David Reiss, a law professor at Brooklyn Law School in N.Y. The new rate is based on an index, such as the prime rate or the London Interbank Offered Rate (LIBOR), as well as a margin on top of that index. LIBOR is used by banks when they are lending money to each other.The prime rate is the interest rate set by individual banks and is usually pegged to the current rate of the federal funds rate, which the Fed increased to 0.25%.

The prime rate is typically used more for home equity lines of credit, said Reiss. LIBOR is typically used more for mortgages like ARMs. The LIBOR “seems to have had already incorporated the Fed’s rate increase as it has gone up 0.20% since early November,” Reiss said.

“The prime rate is influenced by the Fed’s actions,” Reiss said. “We already see that with Wednesday’s announcement that banks are increasing prime to match the Fed’s increase.”

The main disadvantage of an ARM is that the rate is only fixed for a period of five or seven years unlike a 30-year fixed rate mortgage, which means that monthly payments could rise quickly and affect homeowners on a tight budget.

Over the course of the next couple of years, the cumulative effect of a series of interest rate hikes could take an adjustable mortgage rate from 3% to 5%, a home equity line of credit rate from 4% to 6% and a credit card rate from 15% to 17%, said McBride.

“This is where the effect on household budgets becomes more pronounced,” he said.

Homeowners should start researching mortgage rates and refinance out of ARMs and lock into a fixed rate, said McBride. The 0.25% rate increase equals to a payment of $0.25 for every $100 of debt.

Since many factors impact the interest rates of mortgages, consumers need to examine the actual benchmark used by their lender since some existing interest rates already priced in some of the anticipated rise in the federal funds rate, said Reiss. While ARMs expose the borrower to rising interest rates, they typically come with some protection. Interest rates often cannot rise more than a certain amount from year to year, and there is also typically a cap in the increase of interest rates over the life of the loan.

An ARM might have a two point cap for one year increases if the introductory rate of 4% increased to 6% in the sixth year of a 5/1 ARM, he said. That ARM might have a six point cap over the life of the loan, which means a 4% introductory rate can go to no higher than 10% over the life of the loan.

 Based upon the current Fed increase of 0.25%, a homeowner with a $200,000 mortgage would pay an additional $40 a month or $500 a year when the rate resets.

“While this is not chump change, it is also not immensely burdensome to many homeowners,” Reiss said. “The bottom line is that it is worth figuring out just how your ARM works so you can understand what your worst case scenario is and then plan for it.”

Wary of FHA HAWKing Mortgage Access

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The Federal Housing Administration issued its Access Blueprint: What FHA is Doing to Expand Access to Mortgage Credit for Underserved Borrowers. The blueprint identifies a serious problem:

The economic crisis significantly constrained credit making it tough for anyone with less than perfect credit to obtain a mortgage.

According to the Urban Institute, the average credit score for loans sold to the GSEs is 752. Currently, there are 13 million people with credit scores ranging from 580 to 680. Shutting these consumers out of the market hurts American families and undermines our efforts to build more stable communities, create pathways to the middle class, and increase homeownership opportunities for minority and low-wealth borrowers.

A healthy mortgage market serves all qualified borrowers. FHA is committed to finding ways to responsibly increase access for underserved borrowers. (3)

Unfortunately, the FHA’s solutions to this problem seem half-baked. The blueprint states that “Responsible access can be enhanced by ensuring borrowers are well-educated about the home- buying and mortgage finance process.” (3) Under the heading, Homeowners Armed with Knowledge (HAWK), the blueprint states that “Housing Counseling works.  Research shows a strong correlation between housing counseling and mortgage performance.” (4)

As the FHA should know, correlation is not the same thing as causation. It could be that those who have the traits that make them likely to sign up for housing counseling also make them more likely to make their mortgage payments. In fact, the scholarly literature on making people financially capable is not so comforting when it comes to decreasing credit defaults.

The blueprint has other disturbing passages that make one wonder if the FHA is keeping safety and soundness concerns as high priorities. For instance, it states that

FHA primarily selects higher-risk loans for review, e.g. loans evidencing payment challenges. FHA recognizes that this risk-based approach does not accurately reflect a lenders overall underwriting quality as it is primarily focused on non-performing loans. Going forward, we plan to expand our evaluation of loans to include random sampling of performing loans closer to the time of endorsement. This approach provides a more balanced view of underwriting quality. (5)

This is kind of the inverse of the old saw about the drunk who is searching for something for a long time under a lamp post.  When asked why he is looking so long and so unsuccessfully in that one place, he responds that that is is where the light is. FHA appears to be saying that it is going to be spending less time looking in the problem areas because that is where they are likely to find problems. What is that about?#@!?

Obviously, the FHA should be focused on promoting sustainable homeownership for “all qualified borrowers.” (3)  Obviously, the FHA should find ways to “responsibly increase access for underserved borrowers.” (3) What is not obvious is whether the FHA’s blueprint will achieve those goals.