Tag Archives: adjustable rate mortgage

Costly Mortgage Mistakes

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Ship on Rocks

Consumer Reports Money Adviser quoted me in Don’t Make This Costly Mortgage Mistake; How to Weigh Your Options Before Your Settle on a Deal (only available in Spanish without a subscription!) (UPDATE:  NOW IN ENGLISH TOO). It reads, in part (and in English),

As with anything you buy, scoring the best deal on a mortgage or refinancing involves shopping around. Yet 77 percent of borrowers applied for a loan with a single lender instead of checking out several to compare costs, according to a recent study by the Consumer Financial Protection Bureau. “People may well put more time and effort into shopping for smaller products such as appliances and televisions than they do in shopping for the right mortgage,” the bureau’s director, Richard Cordray, said in a statement. But the potential savings from doing your homework are significant. If you get a $250,000 30-year fixed-rate mortgage at 4 percent interest from a lender instead of paying 4.5 to another, you’ll save $26,345 over the life of the loan.

We know it can be difficult to find the right mortgage; the process can be intimidating. Following these steps will help you navigate better:

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2. Decide which type of mortgage is right for you

Before you shop, determine how much you want to borrow, which type of mortgage you want, and how long a term you need so that you can compare lenders’ products.

Most borrowers go with a fixed-rate mortgage, usually for a 30-year term, to spread out the cost of a home purchase over time while making predictable payments each month, says David Reiss, a professor who teaches real-estate finance law at Brooklyn Law School. Those loans make sense especially when rates are low and for buyers who intend to own their house for a long time.

But also consider an adjustable-rate mortgage (ARM), also called a variable-rate or floating-rate mortgage), Reiss says. It has an interest rate that’s fixed for an introductory period of time, then changes periodically, usually in relation to an index. The introductory rate is often lower than the rate on fixed-rate mortgages. For example, the average 30-year fixed-rate mortgage recently had an annual percentage rate (APR) of 3.5 percent, according to Bankrate.com; the average 5/1 ARM (which adjusts annually after five years) was 2.67 percent.

When the rate adjusts, it can sometimes result in a sizable increase in monthly mortgage payments. “ARMs are appropriate for people who anticipate relocating or paying off the loan before it adjusts,” Reiss says, “or for empty nesters who don’t plan to stay in a home for many years.”

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4. Push for a better deal

After you have found the best offer, try to negotiate even better terms. Ask the lender whether he will waive or reduce any of the fees he is charging or offer you an even lower interest rate (or fewer points). You are unlikely to get fees waived from third parties, like those for a title search, government processing fees, and appraiser fees, Reiss says. “But you may be able to cut the lender’s fees, like its underwriting, document processing, and document preparation costs,” he says.

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What Do People Do When Mortgage Payments Drop?

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I went to an interesting presentation today on a technical paper, Monetary Policy Pass-Through: Household Consumption and Voluntary Deleveraging. While the paper (by Marco Di Maggio, Amir Kermani & Rodney Ramcharan) itself is tough for the non-expert, it has some important implications that I discuss below. The abstract reads,

Do households benefit from expansionary monetary policy? We investigate how indebted households’ consumption and saving decisions are affected by anticipated changes in monthly interest payments. We focus on borrowers with adjustable rate mortgages originated between 2005 and 2007 featuring an automatic reset of the interest rate after five years. The monthly payment due from the average borrower falls by 52 percent ($900) upon reset, resulting in an increase in disposable income totaling tens of thousands of dollars over the remaining life of the mortgage. We uncover three patterns. First, the average household increases monthly car purchases by 40 percent ($150) upon reset. Second, this expansionary effect is attenuated by the borrowers’ voluntary deleveraging, as a significant fraction of the increased income is deployed to accelerate debt repayment. Third, the marginal propensity to consume is significantly higher for low income and underwater borrowers. To complement these household-level findings, we employ county-level data to provide evidence that consumption responded more to a reduction in short-term interest rates in counties with a larger fraction of adjustable rate mortgage debt. Our results shed light on the income channel of monetary policy as well as the role of debt rigidity in reducing the effectiveness of monetary policy. (1)

The paper cleverly exploits

the anticipated changes in monthly payments of borrowers with adjustable rate mortgages (ARMs) originated between 2005 and 2007, with a fixed interest rate for the first 5 years, which is automatically adjusted at the end of this initial period. These cohorts experience a sudden and substantial drop in the interest rates they pay upon reset, regardless of their financial position or credit worthiness and without refinancing. These cohorts are of particular interest because the interest rate reduction they experienced is sizeable: the ARMs originated in 2005 benefited from an average reduction of 3 percentage points in the reference interest rate in 2010. (3)

I will leave it to individual readers to work through how they designed this research project and move on to its implications:

The magnitude of the positive income shock for these households is large indeed: the monthly payment falls on average by $900 at the moment of the interest rate adjustment. Potentially, this could free up important resources for these indebted and mainly underwater households. We show that households increase their car purchase spending by more than $150 per month, equivalent to a 40 percent increase compared to the period immediately before the adjustment. Their monthly credit card balances also increase substantially, by almost $200 a month within the first year after the adjustment. Moreover, there is not any sign of intertemporal substitution or reversal within two years of the adjustment. . . . However, we also show that households use 15% of their increase in income to repay their debts faster, almost doubling the extent of this effort. (38-39)

There are all sorts of interesting implications that follow from this study, but I am particularly intrigued by its implications for “debt rigidity — the responsiveness of loan contracts to interest rate changes.” (6) While the authors are interested in how debt rigidity can impact monetary policy, I am interested in how it can impact households. There is much in the American housing finance system that keeps households from refinancing — high title insurance charges and other fees, for instance — but we do not often focus on the impact that rigid mortgage contracts have on the broader economy. This paper demonstrates that the effects are not borne by consumers alone. This paper quantifies the effects on the consumer economy to some extent and reveals that they are quite significant. Policy makers should take note of just how significant they can be.

Reiss on Anatomy of a Mortgage

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MainStreet quoted me in The Anatomy of a Mortgage – Determining Which Fees You Need to Pay. It reads in part,

All mortgages are not created equal, so reading the fine print before you agree to a long-term commitment is crucial.

Mortgage lenders now have become “very risk averse” since the financial crisis and are doing everything “pretty much by the book,” said Greg McBride, the chief financial analyst for Bankrate.com, a New York-based personal finance content company. “The rules on the ability of a homeowner to be able to repay are stricter than ten years ago,” he said. “Niche products have gone back to niche borrowers.”

While lenders are offering fewer risky products such as interest only mortgages to run-of-the-mill consumers, there are still hidden fees and other deceptive practices to be wary of, said Jason van den Brand, CEO of Lenda, the San Francisco-based online mortgage company.

In 2013, the Consumer Finance Protection Bureau issued guidelines to protect consumers from the types of mortgages that contributed to the financial crash. In the past, lenders were approving mortgages that allowed consumers to borrow large sums of money without any documentation such as pay stubs and offered extremely low interest rates to lure people into buying homes.

 “It also doesn’t mean that the potential to get bad mortgage advice has been eliminated,” van den Brand said. “There aren’t bad mortgage products, just bad advice and decisions.”

Here are the top seven things consumers should consider carefully.

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Avoid choosing an adjustable rate mortgage or ARM when it makes more sense to select a fixed rate mortgage. Those low initial rates offered by ARMs are enticing, but they only make sense for homeowners who know that in less than ten years, they plan to upgrade to a large home, move to another neighborhood or relocate for work. 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, which increases your monthly mortgage payment said David Reiss, a law professor at Brooklyn Law School.

While many homeowners gravitate toward a 30-year mortgage, younger owners “should seriously consider getting an ARM if they think that they might move sooner rather than later,” he said. If you are single and buying a one-bedroom condo, it is likely you could sell that condo and buy a house in the future. “That person might not want to pay for the long-term safety of a 30-year fixed rate mortgage and instead save money with a 7/1 ARM,” Reiss said.

Reiss on Low Credit Scores and Mortgages

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MainStreet quoted me in A Low Credit Score Does Not Prevent You From Purchasing a Home. It reads in part,

While consumers who have low credit scores have fewer options to choose from, many can still qualify for a mortgage.

Lenders determine the mortgage rate based on a potential homeowner’s credit score, amount of down payment and how much debt he has compared to his current income.

What Your Credit Score Means

Credit scores play a large factor in the interest rate a borrower will receive because lenders are determining the likelihood of someone defaulting on a loan or missing payments, said Jason van den Brand, CEO of Lenda, a San Francisco-based online home mortgage service.

“It’s important to remember that the costs of a loan are closely associated to how ‘risky’ it is to give the loan,” he said. “If you look like a riskier borrower, your loan will cost more.”

Low mortgage rates can play a substantial factor in a homeowner’s ability to save tens of thousands of dollars in interest. Even a 1% difference in the mortgage rate can save a homeowner $40,000 over 30 years for a mortgage valued at $200,000.

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Both an adjustable rate mortgage (ARM) or a Federal Housing Administration (FHA) mortgage are good options if homeowners are concerned about receiving a lower interest rate and have not been able to accumulate the standard 20% down payment.

The biggest benefit of ARMs is that they offer lower interest rates than the more common 30-year fixed rate mortgage and are good options for first-time homebuyers. 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.

FHA loans can be a good option, because they require a much smaller down payment of 3.5%.

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Given that young households tend not to have the savings for a substantial down payment, FHA loans can be particularly attractive, Reiss said.

The Future of Fannie and Freddie: The Definitive Panel!

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The  NYU Journal of Law & Business has published The Future of Fannie and Freddie (also on SSRN):

This is a transcript of a panel discussion titled, “The Future of Fannie and Freddie.” The panelists were Dr. Mark Calabria from the Cato Institute; Professor David Reiss from Brooklyn Law School; Professor Lawrence White from NYU Stern School of Business; Dr. Mark Willis from NYU’s Furman Center for Real Estate and Urban Policy. The panel was moderated by Professor Michael Levine from NYU School of Law. Panelists looked at economic policy and future prospects for Fannie and Freddie. My remarks focused on the goals of housing finance policy.

The actual panel occurred some time ago, but it remains current given the limbo in which housing finance reform finds itself.

Reiss on Being Financially Overextended

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US News & World Report quoted me in 5 Signs You’re Financially Overextended. It reads in part,

 Are you managing your debt? Or is it managing you? If you’re stuck in a money quicksand trap, you may not even realize at first that you’re in a financial predicament, especially if you’re sinking slowly and have been poorly managing your cash for a long time.

But if you suspect your debt is a disaster in the making, there’s no need to wait and see if your financial life will someday implode. If you’re pushing your finances to the limit, the signs are already there that you’re overextended. Just look for them. And if you spot one, don’t ignore it. Here are five of the biggest clues that trouble is coming.

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5. You’ve created opportunities that could make you overextended. If you have a lot credit cards or lines of credit you rarely use, you could, in theory, end up spending a lot of money and getting yourself into trouble that way, but having those lines open isn’t itself a bad sign. It’s a sign that you have good credit, and your creditors trust you. Still, it’s good to remember that if you aren’t monitoring yourself, you could ultimately max out and find yourself buried in credit card debt.

At least in that scenario, you have control over what may or may not happen. Some homeowners, however, put themselves at risk for becoming overextended when they get an adjustable rate mortgage or a home equity line of credit in which the interest rate “may float with some kind of index like the prime rate or [London Interbank Offered Rate],” says David Reiss, professor of law and research director at the Center for Urban Business Entrepreneurship at Brooklyn Law School in Brooklyn, New York.

“So if interest rates rise dramatically, the home equity line of credit can become unaffordable,” he says. “Interest rates have been very low for some time, so homeowners are not focusing on this risk, but if they were to rise – and they can rise suddenly – homeowners may face a rude awakening.”

In which case, you may want to refinance and position yourself to avoid becoming financially overextended if the interest rates someday jump. Because what happens to anything when it’s stretched beyond its limits? It – or you – will snap.