Guest column

By Walt Lydic
Special to the Coastal Point

The home mortgage loan that served as the fuel for the first housing boom of the new century, the ARM or adjustable rate mortgage, will be soon turning into an arm and a leg for many homeowners.

The Mortgage Bankers Association reports that over $1 trillion of ARMS will have their first adjustments next year, and thanks to Chairman Greenspan, new Chairman Bernanke and the rest of the Federal Open Market Committee, most will see a full 2 percent increase in the interest rate.

If only it were that simple. But when you look at what a 2 percent rate increase does to a monthly payment, you realize that the piper has come a-calling. A $250,000 loan on a three-year ARM taken out in 2004 would have carried a rate of about 5.25 percent and a payment of $1,380 per month. Fast-forward to 2007 and we now find the rate has gone to 7.25 percent and the payment is now $1,739, an increase of about 20.5 percent.

Since 2004, wages and salaries have trailed far behind what would be required to keep up with the mortgage payment, increasing a total of only 7.8 percent according to the Labor Departments’ employment cost index. But remember, this is the first adjustment for these loans, and when you review your loan documents you will most likely find that they will adjust every year after the initial fixed period.

The continued rate hikes have brought the main ARM index, the one-year Treasury, up to 4.9 percent. That index, added to the margin contained in the loan documents, will determine the new rate (an average margin is between 2.25 percent and 2.75 percent). So even if rates stay the same next year you will see another rate hike and payment increase.

Borrowers chose the ARMS not only for lower payments but for specific purposes, as mortgages are increasingly used as any other financial instrument, a tool for managing their portfolio. Real estate investors use them for managing cash flow, passing on interest rate risk to their tenants.

Baby boomers, intent upon an imminent retirement, opted for the adjustable rate, waiting for the day when they sell their primary home, paid off the new one and became “mortgage free.” Condominium developers, aware that their project would sell quickly, chose not to secure costly Fannie Mae prior approval. Thus, competitive fixed financing was not available to the buyers of the units and the affordable ARMS kept the payments down until the project became eligible.

Last year, when Mr. Greenspan spoke to Congress about a conundrum, he was speaking of the flattening yield curve. The long-term rates were just inching upward, while the short-term rates were rising fast enough to eventually overtake the longer maturities. The 30-year fixed-rate mortgages once again became the mortgage of choice, providing payment certainty and stability, while the ARMS continued climbing.

The very popular “exotic” ARMS, with eye-catching low rates, interest-only options and payment caps, have drawn dire warnings from regulators, analysts and even the former Fed chief. Especially popular in areas with the highest-priced real estate, they are being blamed for the increase in mortgage delinquencies and are considered one of the reasons that the high cost areas are ripe for a decrease in values. Economists are saying that the payments on some of these loans could increase anywhere from 50 percent to 90 percent.

The silver lining shining through the market is the relative stability of the fixed-rate loans. Much of the $1 trillion in mortgage debt will be refinanced into 15-, 30- or even 40-year fixed loans. Still others will select another ARM product, keeping their payment low and trying to match the term to their housing goals.

The term “mortgage free” has been largely replaced by the term “cash flow management.”

Walt Lydic is president of Kaylor Kent Mortgage in Ocean View and is the only NAMB-certified mortgage consultant in Delaware. He can be reached at (302) 539-9120.