What causes an ARM to adjust? (loans, real estate, second mortgage, buying)
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So all those people who bought a home with an ARM. Why did the ARM have to reset a few years later?
I'm trying to figure this out.
Is it because houses went up so fast, then people suddenly couldn't afford them, so prices started to drop, then they (not sure who they is) started losing money so they had to adjust the interest rate upwards?
What would have happened if the ARM didn't adjust upwards?
It depends on the type of loan. Not sure what you mean by "reset" a few years later. Usually, after a certain time, ie 3 years, or 5 years, the rate becomes adjustable. It has nothing to do with house price. It has to do with what type of loan one has and the adjustment is based on current rates, plus whatever is in that particular loan. I'm sure there are many, many different types of loans with arms. Interest only is one.
Some arms have not adjusted upwards. People who have had arms adjust recently have said that they are enjoying low rates/payments right now.
It's in the nature of the beast. ARM stands for "adjustable rate mortgage" and after the 2 years, or 3 years, or whenever stated in the mortgage contract, the rate changes. When it does, the mortgage payment goes up. If you were paying $1200 per month for your mortgage before the reset, you could find yourself paying $1500-1800 after it resets.
It has nothing to do with the value of the house. Actually, the values have been plummeting, often below the outstanding mortgage. At that point, many folks walk away, figuring why throw good money after bad.
If the ARM (rate) didn't adjust upwards (fixed rate), the payment would remain the same, and most people would still be able to afford to pay, as nothing would have changed. However if the house value went down sharply, a lot of them would walk away anyhow, as they'd still be underwater.
I've always heard the ARM was ideal for those who were short-timers -- those who would only be in that home for a short time.
The problem comes when you can't sell the home when you thought you were going to because there's way too much inventory competing with it, and when selling the home would incur a larger loss than you're able to handle (which is really two sides of the same coin).
I thought a big part of the crisis was because people had ARMs. I'm wondering if this crisis would have been so bad if all these people were put into a fixed rate mortage?
I thought a big part of the crisis was because people had ARMs. I'm wondering if this crisis would have been so bad if all these people were put into a fixed rate mortage?
Less likely. The month to month and year to year change in total monthly payment would be much much less in a fixed mortgage.
ARMs were probably the only way to get some people in to mortgages though. The problem is some of those people probably didn't have an intention to sell within a few years (and then they couldn't anyway, see my post above).
It's not just ARMS, it's also interest-only mortgages (so no equity was accrued at all), zero-interest for a short time mortgages (so when the interest starts being due the monthly goes up), $0 down mortgages (again, no equity), no documentation mortgages, 80/20 mortgages to avoid PMI, and highly leveraged mortgages (much higher than 28/36% of gross income).
The problem started when people bought homes as a way to make money instead of as a place to live.
ARMs and interest-only mortgages are based on the premise that real value of the property will increase along with the payments and that the people buying it will have an increase in income to afford the higher payments down the road and that there would be buyers for the old house when they were ready to sel.
It was a house of cards that was fine for awhile, but when salaries stopped climbing and the need for mid-level houses fell as the boomers got older, the whole thing collapsed.
People discover that they aren't getting the raises or increased income they expected, their investments aren't paying off as expected and now they can't sell their home for what they paid or sometimes for any amount and they've got a mortgage payment they can't afford. So they default and walk away.
Home equity loans were easy to get, too. People took second mortgages with plans to improve, live there a few years, sell for more than they put into it and move on. But when houses stopped selling, the whole thing came tumbling down.
The interest-only, no document mortgages were a last-ditch effort to keep the whole thing from falling over by bringing more buyers into the market. It only worked for a short time.
I thought a big part of the crisis was because people had ARMs. I'm wondering if this crisis would have been so bad if all these people were put into a fixed rate mortage?
Fixed rates are usually higher than ARM rates so that means less people would be able to afford the monthly payments. That equates to less loans being approved. IMO, ARM loans itself wasn't the problem. It was that and (among others of course) approving subprime mortgages where people who really didn't qualify for a loan were still approved.
Quote:
Originally Posted by sheenie2000
So all those people who bought a home with an ARM. Why did the ARM have to reset a few years later?
I'm trying to figure this out.
Is it because houses went up so fast, then people suddenly couldn't afford them, so prices started to drop, then they (not sure who they is) started losing money so they had to adjust the interest rate upwards?
What would have happened if the ARM didn't adjust upwards?
ARM = Adjustable Rate Morgage. People who got these loans took a risk and many lost. Hence, our problem (again, with other factors contributing). They thought they would make more money. They thought the home values would increase. They thought they would be able to flip the house before the ARM rate reset to the current rate. They thought a lot of things and they thought wrong.
It's not so much the housing prices increased but rather the rate. I could be wrong on this because I'm just speculating. The ARM rate will adjust, however, regardless of the real estate market. It's in the terms of the contract. Some terms are a couple of years, others are longer. That is how I understand it.
So all those people who bought a home with an ARM. Why did the ARM have to reset a few years later?
I'm trying to figure this out.
Is it because houses went up so fast, then people suddenly couldn't afford them, so prices started to drop, then they (not sure who they is) started losing money so they had to adjust the interest rate upwards?
What would have happened if the ARM didn't adjust upwards?
Here is a graph of the CMT (Constant Maturity Treasury), which is one of the indexes used to set the ARM rate. It is fairly reflective of the prime rate. The 2nd graph shows the rate over about 50 years. So if the CMT went up then the rate went up, but if it went down then the rate likely went down also. So it's a matter of timing, as you see, the rate went down in 2003 then came back up. At that time many ARM loans adjusted based on the new rate at the end of the loan term (1, 3, 5 year, etc...).
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