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What Happens When All Those 5/1 ARM Mortgages Reset At 7%+?


The rising cost of homes and skyrocketing mortgage rates have prompted more buyers to take out adjustable-rate mortgages or ARMs — one of the financial products blamed for the 2006 housing crisis

ARMs offer a low interest rate on mortgages, usually for three to 10 years — and then the rate adjusts, based on a fluctuating benchmark rate plus an additional margin, such as 2 percent. 

About 10 percent of mortgages were ARMs as of January 2022, up from a 10-year low of 4 percent in January 2021, according to data from CoreLogic.

Part of the reason for the increase in ARMs is that the average rate for the benchmark 30-year fixed mortgage has been on a nonstop, near-vertical increase for several weeks and is now at 5.29 percent.

When you could get a 30-year fixed mortgage at about 3.3 percent in 2012, it made little sense for most homeowners to take on the risk of an ARM mortgage at 2.74 percent. The difference or “spread,” was just 0.56 percent.

However, today, the average annual percentage rate for a five-year adjustable-rate mortgage (ARM) is 3.634 percent, according to rates provided to NerdWallet by Zillow. That’s an estimated 1.65 percent spread.

A 5/1 ARM is a type of variable or adjustable rate mortgage loan (ARM) with a fixed interest rate for the first five years. After five years, the 5/1 ARM switches to an annual adjustable interest rate for the remainder of its term. There are other types of ARM loans where the rate adjusts every six months after an initial five, seven or 10 years.

The initial ARM rate can represent big savings for homebuyers struggling to afford record-high home prices. Median prices for homes have increased almost 27 percent since the beginning of the pandemic to close to $400,000, according to Realtor.com. These prices have pushed many buyers out of the market.

For example, a buyer who puts 10 percent down on a $400,000 home and finances the mortgage with a 30-year loan at today’s rates will have a monthly payment of $1,806 (plus taxes and insurance). But with a 5/1-year ARM, the initial rate would be $1,636 — a savings of about $170 a month.

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The Great Recession was triggered in part by people with two-year sub-prime ARMs who planned on selling or refinancing before the fixed rate period ended and the adjustable period began. Then the bottom fell out of the housing market. Upside down on their homes and unable to sell or pay the higher rates, people were foreclosed upon at unprecedented rates.

Peter Schiff, the CEO of U.S. investment advisor and broker-dealer Euro Pacific Capital, has been predicting another recession for years. A Manhattan investor and precious metals dealer, Schiff is known for being bearish on the U.S. economy and the dollar.

“When 30-year Treasury yields hit 5%, 30-year mortgage rates will likely exceed 7.5%. What will happen to housing and financial markets, and the economy with mortgage rates that high?” Schiff asked in an April 19 tweet. “Think about all the 5/1 ARMs that will reset. Where will homeowners get the extra cash to pay?”

“It’s 2005-2007 all over again, but worse” tweeted Mr. Ryan’s Slayborhood, who claims to work in mortgage banking, in a reply to Schiff.

However, financial experts say this pandemic housing boom is different from the boom leading to the 2006 sub-prime mortgage crisis. Banks have stricter lending standards. Some of the riskiest features — prepayment penalties that keep borrowers locked into loans with expensive terms — are gone, according to The Mortgage Reports.

Adjustable-rate mortgages got a bad name in the 2006 housing bubble because they were sold to buyers who couldn’t qualify for a conventional mortgage. The initial rate meant that those buyers’ monthly payments were lower, making lenders more willing to push through the loans, according to research from Brookings Institution. 

When the housing market crashed and the ARMs reset to higher rates, those buyers couldn’t handle the monthly payments and lost their homes.

Photo by Tom Rumble on Unsplash, https://unsplash.com/@tomrumble?utm_source=unsplash&utm_medium=referral&utm_content=creditCopyText https://unsplash.com/s/photos/suburbs?utm_source=unsplash&utm_medium=referral&utm_content=creditCopyText



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