Homebuyers give risky adjustable-rate loans another look

Aug. 20—Once notorious, adjustable-rate mortgages have made a comeback lately as homebuyers wrestling with rising interest rates take on greater financial risk in exchange for lower payments, recalling for some the lending excesses that contributed to the housing bust of 2006-07.

ARMs, as the home-loan products are called, represented 7 percent of all U.S. mortgage applications during the week ended Aug. 12, more than twice January's rate but down from a peak of 9.5 percent a month and a half prior.

The choice of ARMs over fixed-rate loans lowers a borrower's costs for a certain duration, maybe five to 10 years, after which the interest rate may increase along with monthly payments. Some ARMs cap increases; all carry risk that homeowners could end up paying more money if they don't sell or refinance.

Significant reforms have been put in place since the housing bust, when a crush of homeowners unable to keep up with their mortgage payments triggered a global financial crisis. Among other changes, banks and credit unions no longer underwrite mortgages to borrowers with unverified incomes and assets.

People in the business say the option's benefits and drawbacks can work well for sophisticated borrowers familiar with the products — but that first-time homebuyers might want to think twice.

Bakersfield appraiser and home market observer Gary Crabtree called ARMs a "death knell" to the market. He blamed them for the recession more than 40 years ago when, during the Carter administration, a mortgage product that over time increased borrowers' monthly payments allowed people to qualify for loans they couldn't afford two or three years later.

He expressed a general skepticism of ARMs.

"ARMs never made sense in a down-trending market," Crabtree said. His latest home-market report from late July showed Bakersfield was on pace for a third-consecutive monthly decline in median home sale prices, a key gauge.

Lenders have restructured ARM products in recent years by giving them a longer period with the initial, guaranteed rate, the Bakersfield real estate team of William and Sheeza Gordon said by email. They noted some of the loans carry helpful caps on rate increases. But their endorsement of ARMs only went so far.

"I would only recommend them to more experienced buyers who are willing to gamble their future and expect their income to remain steady or increase," the Gordons wrote.

Chuck Smith, senior vice president and chief lending officer at Valley Strong Credit Union, said ARMs have remained a relatively steady share of mortgage loans at the Bakersfield-based institution. As he sees it, the loan product has gotten a "bad rap."

"That was not what caused it," Smith said, referring to the bust. "What caused it was people were getting put into homes they couldn't afford." ARMs exacerbated the bust, he added.

The main benefit of an ARM, he said, is that it boosts a homebuyer's ability to afford a home. Smith agreed the arrangement isn't necessarily the best for first-time buyers, depending on their cash flow, but that it saves money for people who don't plan to stay in the home long or who are able to refinance before the loan's interest rate rises.

President and CEO David King of Bakersfield-based Safe 1 Credit Union said by email ARMs were partly to blame for the financial crisis, but they didn't play as big a role as some might guess.

King listed what he figures contributed: lack of regulation, unscrupulous appraisers, heedless rating agencies, hungry lenders and loans with bad features like interest-only payments.

Safe 1 doesn't do much ARM lending, he said, because people are usually better off with traditional, fixed-rate loans. They remain historically reasonable, he added, at about 5.25 percent these days for a 30-year term.

He suspects ARMs will become less attractive if interest rates continue to rise. But he cautioned against making financial decisions based on guesses on where rates are headed, "because it is just that, a guess."

"Like any other decisions of significance," King wrote, "research and understanding are paramount when taking out a mortgage, especially an ARM."