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The Benefits of "Freezing" ARM Loans

By
Real Estate Agent with The Landry Team-Keller Williams Realty

In the recent months it has become extremely apparent that many people bought homes in 2003, ‘04, and ‘05 that they could not afford. In fact, many of these people should not have been able to purchase a home at all.  The reason that they were able to purchase said homes was becuase of great deals on ARM (Adjustable Rate Mortgage) loans.  Many of these loans had introductory teaser rates like 2% that made it easier for people to qualify. Most of these loans had a fixed rate for either 1,3 or 5 years and after that they can go up. Some can even go WAY UP.

These loans are coming out of their fixed rates currently, and that is why we are seeing such a hike in foreclosures. The bottom line is that many of these people should not have purchased homes that they couldn't afford. But to that same token, banks should not have loaned them the money if they were not qualified. So here we have a pickel.

Foreclosures not only cost banks thousands and thousands of dollars to do, (anywhere from $30,000-$70,000) depending on the price of the home. They also reak havoc on the lives of many families. The recent numbers run show that if a signifcant amount of the ARM loans coming due go into foreclosure, it could create a national recession on the economy. And what is the last thing that we want? An Economy Recession!!

So whats being done to help? The Bush Administration has put forth a plan to have mortgage companies "Freeze" the rates on these ARM loans. Providing a Win-Win situation.

Example: Lets say that John Smith purchased a home in early 2004 for approx $250,000 @ a rate of 4%(which is a great rate). Of course, it was 2004, so Mr. Smith probably had to put little or no money down on this loan, making it 100% financed. That means that Mr. Smiths mortgage payment (excluding taxes and insurance) would be approx. $1,190/month. The bank is earning interest on this loan amount and Mr. Smith can afford his payment. Well in early 2008 Mr. Smiths 3/1 ARM loan comes to its first adjusted payment. Rates are still decent, but not what they once were. Mr. Smiths interest rate jumps to 6.5%. Now Mr. Smith is paying out a mortgage of approximatly $1,500! A $300+ increase!  In our example Mr. Smith barely was able to qualify for the loan payment of $1,190/month. Now, with the larger payment coming due, he won't be able to pay it.

Here is where the problem lies. Mr. Smith will loose his home, and any credibility with lenders for the next 7-10 years. The mortgage company will spend thousands of dollars to foreclose this property. Only to have it sell for far under market value because of the foreclosure status and current market fluctuations. So that home that has a $250,000 mortgage will cost the banks approx $50,000 to foreclose on. Making the banks vested interest $300,000. Well, the market is tough, and the home has been neglected during the foreclosure process, it needs minor cosmetic repairs and a new lawn. Therefore its current market value is only about $220,000. Factor in the cost of Real Estate brokerage fees, and closing costs of approx $20,000. Now the bank is left with a property that they have lost $100,000 on, and thats if it sells at full asking price.

Altough the bank will not make as much money on a homes' interest rate becoming locked; they will save hundreds of thousands per home to keep the current owners in it. This is where it becomes a Win-Win situation. The Smith Family keeps there home, at a payment they can manage. The bank makes a moderate amount of interest off of the loan, and they do not incur any legal or carring fees for the property. Both parties are safe from financial ruin. It may not seem like the bank would care enough to do this, but remember, if they lose $100,000 on 100,000 properties in 1 year, they lose $10 Billion dollars. Thats enough to put them out of business.

All in all the proposal is a great step towards stopping the foreclosure process. Sure, it has its flaw, but as a whole it makes a tremendous impact.

Liz Landry * The Landry Team * Keller Williams Realty First Coast * 904-803-2459 *

 

Posted by

The Landry Team - Orange Park Real Estate Specialist

Comments (2)

Anonymous
jdj
and what happens when the loan is unfrozen??? Didn't these people just have 3 years of frozen rates? The frozen rates are what got us in this mess to begin with.
Dec 05, 2007 10:48 AM
#1
Liz Landry
The Landry Team-Keller Williams Realty - Jacksonville, FL

RESPONSE:What happen was that the rates were not fixed for the full length of the loan, they were only fixed for a few years(3 was very common).  When we say "frozen" we are reffering to fixing the loan interest rate and turning into into a conventional 30 year fixed instead of an ARM loan. So the loan rates would not adjust at all. They would essentially become a "conventional loan". Thanks for your questions!

 

Dec 05, 2007 11:20 AM