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Experts advise weighing mortgage options
By Dan McCue
Staff Writer
A recent tumble in interest rates on 30-year fixed loans and fears fueled by analysts’ forebodings about a looming surge in the nation’s foreclosure rate are prompting many homeowners across the country to convert their existing adjustable rate mortgages to new ARMs with a more distant adjustment date or to other, “safer” financing vehicles.
According to the Mortgage Bankers Association, more than $300 billion worth of hybrid ARMs are about to adjust for the first time, with the figure rising to $1 trillion worth in 2007.
But don’t assume the days of the adjustable rate mortgage are over, local mortgage brokers said.
While the consensus is that ARMs sales have slowed by 10% to 15% compared to last year, they will still make for a very strong year in real estate sales, leading the tri-county market to its fourth strongest year ever, said Kevin Brookes, a mortgage specialist with Wachovia in Charleston.
In sections of the region where prices have held steady, namely Mount Pleasant, Daniel Island, Kiawah and Isle of Palms, the average mortgage is about $300,000. Borrowers are continuing to rely on ARMs to buy more house than they could in light of the higher monthly payments associated with a 30-year fixed-rate mortgage.
No matter how small the gap becomes between interest rates charged for the more expensive 30-year fixed-rate mortgage and its less costly cousins—at one point in October they closed within a percentage point of each other—ARMs are going to remain some people’s financing vehicles of choice.
“It all depends upon what your objectives are and what your financial situation is,” said Gary Harwyn, president of Daniel Island Mortgage. “The truth is, there is no one-size-fits-all, perfect loan. Every loan has its drawbacks and benefits. The key is finding the loan that benefits the client most.”
In early October, the mortgage giant Federal Home Loan Mortgage Corp., known as Freddie Mac, reported the 30-year fixed rate mortgage had fallen to 6.3%, continuing a slide that began last summer, after financial analysts became convinced that a slowing economy would ease inflation pressures and keep the Federal Reserve from raising interest rates further.
However, the drop in the 30-year rate, coupled with homeowners wanting to refinance their ARMs before their current mortgages reset to a higher monthly payment, has inspired a rebound in applications.
“Home refinancing rose 18% (recently), accounting for almost half of all mortgage applications,” said Frank Nothaft, Freddie Mac’s chief economist, in a written statement released in October.
Although ARMs have waxed and waned in popularity over the years, they surged in popularity over the past five years as the Federal Reserve cut key short-term interest rates to stimulate the economy.
Wachovia’s Brookes said about 90% of the mortgages he writes are ARMs, and about 80% of those are of the interest-only variety.
As is the case of the other brokers, he said most clients are opting for ARMs because they don’t plan to stay in their homes forever and because they can dedicate the money they’re saving on monthly payments to other financial vehicles, such as IRAs or money market accounts.
“The one thing I try to make clear to all my clients is that while an ARM provides you with a discount, you’re getting that discount because you are assuming a risk,” Brookes said. “Where people get into trouble, and ARMs get a bad rap, is that they don’t adequately weigh the potential risks in light of their financial realities or (they) make assumptions about their financial future that are unrealistic.”
Many of those who are currently refinancing are doing so because they went for a shorter-term ARM back in 2002 and didn’t like the consequences, he said.
“Those people went through their first adjustment in 2005, and their payments likely jumped significantly. So now they’re looking to extend the adjustment period the next time by refinancing into a longer-term vehicle,” he said.
There is one other factor helping to boost the rate of refinancing: the realization among many consumers that like any other financial vehicle, loan rates seem to follow cyclical patterns, Brookes said.
“I’ve been in this business 11 years, and even in that short a period, I’ve probably seen four refinance booms,” he said. “That’s why I think a lot of people still remain skeptical about going into a fixed-rate situation. They see the rate situation evolving back into their favor again.”
Jamie Culler, owner of New South Mortgage, which has offices in Charleston, North Charleston, Mount Pleasant, Beaufort and Summerville, said most people who opt for an ARM choose the fixed-period version.
The rates on these loans are fixed for one, three, five, seven or 10 years and begin to adjust, typically, every six to 12 months after that initial fixed-rate period elapses.
“This provides the client with a lower rate for the initial fixed period than a more traditional fixed-rate loan, but requires them to tolerate the risk of their rate adjusting after that period,” Culler said.
The longer the initial fixed-rate period, the higher the rate; the shorter the fixed-rate period, the lower the rate.
An Option ARM is a completely different type of loan that allows for negative amortization and an interest-only option as well. These are the loans that have gotten the most bad press of late, but Culler maintains that they are good for certain situations.
“They are great loans as long as the client understands the risk involved,” he said.
Going forward Culler sees more, innovative mortgage products coming out. Fannie Mae, for instance, recently changed its popular My Community program to include a 40-year amortization feature and an interest-only feature, he said.
“At New South Mortgage, we are also seeing more construction business due to an innovative product that we rolled out six months ago that allows buyers to build their dream home with no money out of pocket at an extremely competitive rate,” he said.
The key to successfully choosing the right mortgage is to match the loan vehicle to the person, Harwyn said.
“Everybody that walks through my door is different, but the one thing they have in common is the need to understand the benefits and the consequences of each of the types of loans they are considering,” he said. “Right now, I get a lot of requests for information about ARMs because people are more mobile and intend to stay in a new home only five to seven years, rather than buying for life.
“Now, that doesn’t mean that in every case a particular ARM or any ARM is going to be right for them. You have to talk candidly about their financial situation and then give them a choice of loans.”
In the end, Harwyn said, making the right choice on a loan comes down to how conscientiously the broker takes his duty to give the client all the information needed to make a sound decision.
“ARMs in and of themselves are not the problem,” he said. “The problem is aggressive lenders who are not being fair to their clients and talking them into the wrong product for their circumstances.”
Dan McCue is a staff writer for the Business Journal. E-mail him at dmccue@charlestonbusiness.com.
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