Here's a staggering statistic. According the New York foreclosure inventory the rate for prime ARMs increased 23 basis points, while the rate for prime FRM loans increased 2 basis points. The foreclosure inventory rate for sub-prime ARM loans increased 131 basis points, while the rate for sub-prime FRM increased 12 basis points.
Many mortgage professionals offered the 2-3 year ARM model with the hope that the borrowers will have better credit before the ARM expires to qualify for a better loan. Unfortunately, for a lot of borrowers this isn't the case. Many of them still have the same credit profile and some even worse. This is more prevalent with purchases. After depleting their reserves for down payment and closing cost, many of them utilized credit cards to stay afloat. Many borrowers used credit card to furnish their new home. Those who moved from the city to the suburbs used credit to buy a new car. Instead of improving their credit profile, they now have more debt exposure than ever. It is almost impossible to qualify or to get a new mortgage that benefits them.
Once ARM expires and their monthly payment increases, they could no longer sustain their payments. Borrowers do not have any dramatic increase on their salary or have any new source of income and having an extra $300-$900 increase on monthly payment is impossible to swallow.
What is more disturbing is that many mortgage professionals gave them a 2-3 year pre-payment penalty. ARM is a temporary solution to "get them into the house", is it expected that they will try to refinance before the ARM expires. Why give them a pre-pay that is as long as or longer than the ARM expiration date? Hello! Are we supposed to be the "experts" here? What a foresight that is! Or we just don't care as long as we have a fat commission check. After all pre-pay means better pricing and better pricing means more Yeild Spread Premium.
Another factor is the LTV issue. 2-3 years is not enough to build equity. No equity plus bad credit profile then your borrower is stuck. Many lenders have change guidelines that most high LTV sub-prime programs are now extinct. It is now more difficult to qualify a sub-prime borrower with a high LTV. To make matters worse, market value of homes in a lot of areas have declined. Those who took interest only 2-3 year ARM products will have a rude awakening. They have LTVs more than 100%. The payment shock an interest only ARM product is more extreme than fully amortize ARMs.
As you can see based on the statistics prime ARMs has 23 basis points vs 131 basis points for sub-prime ARMs. Most prime ARMs have longer terms 5,7 and 10 years, while sub-prime has the 2-3 model.
Now if we compare the numbers of foreclosure between ARM and FRM we see a big difference. It's all about payment shock.
I am not knocking down ARM products. They exist because there is a need and a market for it. Why pay a higher rate 30 year fixed program if you are going to refinance or sell your home in a few years. You should discuss with your client on how long they are going to hold on to the mortgage. You should also give them a game plan to build enough equity and improve credit to prepare the exit from their current ARM mortgage. We are not just Mortgage Consultants we are also Mortgage Planners. They are using ARM only as a temporary vessel. How long is temporary? Is a better question to ask! Give them a realistic time frame to execute their plan.
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You hit the nail on the head here, the ARM is a TEMPORARY fix to their current financial situation. That 2 or 3 year comes up fast. Great Post!