Adjustable Rate Mortgages making a comeback
In February, new home sales fell to their lowest levels since 1963. And existing home sales were also way down -- their third biggest monthly decline ever. As the housing slump continues, banks and realtors are once again looking at creative ways to spark the market. One goes back to the future -- the Adjustable Rate Mortgage, also known as ARM.
After accounting for nearly 70 percent of all mortgages issued during the housing boom, ARMs vanished during the bust. Now they're making a comeback.
CBS News Business and Economics Correspondent Rebecca Jarvis told "Early Show" viewers what they need to know about ARMs.
While they never actually disappeared, they were far from as popular as they had been.
"Far from as popular because, if you look at the height of the housing market, Adjustable Rate Mortgages accounted for about 70 percent of all the mortgages out there. Then, of course, all these people got them, like the loan officers were giving them out like candy, people who shouldn't be getting them got them, and they had these ultra-low teaser rates to entice people into them, and then they started resetting at massive rates," Jarvis explains. "At the same time, this was going on, the housing market was declining, and people were losing jobs. That's why you saw the bust. But (ARMs) are making a bit of comeback now. They're projected to climb to 10 percent of the market by the end of this year."
According to Jarvis, that comeback is really attributed to two things: "First of all, the market has become more conservative. So banks have made these more conservative, more consumer-friendly, more economic-friendly instruments," she explains. "On top of that, they just look so much cheaper on the surface. When you look at the average 30-year fixed-rate mortgage right now in this country, it's 4.81 percent. Versus an adjustable rate mortgage, the interest rate you're going to get on that is significantly less. It's 3.41 percent. So, the fixed rate is looking, on its face, more expensive than the adjustable rate."
While the fixed rate in and of itself is so low, there is more than meets the eye. The initial teaser rate is only for the first five years.
"Right<" Jarvis remarked to co-anchor Erica Hill. "So it depends on the term of your Adjustable Rate Mortgage. But it is for five years. And if you look at sort of the numbers behind these things, let's say you're taking out a $200,000 mortgage. If you have it at an adjustable rate, you're going to save about $10,000, versus a 30-year mortgage. You're going to save about $10,000 in those first five years. It's the years after that that become more of a question mark, because obviously the rate can change," she adds.
Jarvis says the ideal candidate for an ARM is someone who thinks they're going to be in a house for a short period of time. "Before that rate changes, and before it gets much more expensive to have the mortgage. That said, there is a caveat to all of this, and that is if you think you're going to be in a house for a short period of time, and you think you're going to be able to sell it. Guess what? People are not -- this is not a seller's market," Jarvis point out.You can't count on the market, as you could years ago.
"You can't. The data that we got out just this week shows that existing home sales were down 10 percent in the month of February." Jarvis said. "They are now prices at nine-year lows. The average existing home, the median existing home on the market is selling for about $156,000. So there are definitely issues in the market already."
Given all of those issues, if you think an ARM is the right option for you, what are the things you need to go going in before you sign on the dotted line?
"One of the most significant things is how long are you going to have that fixed rate. That's called the ARM Term," Jarvis says. "So, maybe it's five years. Maybe it's seven years. On top of that, there are a number of caps that you need to be aware of."
"First of all, the initial cap -- how high can your interest rate adjust in that first year after it's no longer stable? The periodic cap -- how high can it go over the entire term of the mortgage? And then lastly, the lifetime cap -- what's the highest possible rate that you could be paying over the life of that loan? You need to know all of those things, because obviously, that's going to make a big difference on what you pay on a month-to-month basis," she says.
Bottom line: "You need to make sure, no matter what happens, you can afford that maximum lifetime cap," Hill said.