The Evils of Adjustable Rate Mortgages

I was talking with someone this morning about ARMs and the sort of financial havoc they have been wreaking upon a population who was assured that they would be able to refinance before the “adjustable” portion of the mortgage kicked in. During that conversation, I realized the reason why banks were so interested in getting people into ARMs, and it didn’t really have anything to do with trying to weasel houses away from people.

Adjustable Rate Mortgages usually have a rate adjustment that kicks in after a few years. Quoting the fed: “With most ARMs, the interest rate and monthly payment change every month, quarter, year, 3 years, or 5 years. The period between rate changes is called the adjustment period. For example, a loan with an adjustment period of 1 year is called a 1-year ARM, and the interest rate and payment can change once every year; a loan with a 3-year adjustment period is called a 3-year ARM.”

These “financial products” have been sold with the idea that buyers would want to refinance with a traditional “fixed rate” mortgage before the adjustable period kicks in. For borrowers who would not otherwise qualify for a traditional mortgage, this gave a way to increase credit score through timely mortgage payments as well as the ability to “own” a house. (Not that any of this stuff is “owned” until the bank isn’t able to take it away for sometimes arbitrary reasons, but whatever…)

I contend that their intent is to keep people from owning (and I do mean owning as in “don’t owe the bank money”) their own house by minimizing the amount of potential equity in their houses. They can accomplish this by the way that mortgages work — at the beginning, virtually none of your monthly payment is applied to the principal (increasing equity), and at the end, almost all of it is applied to the principal. But — what if you never were able to get beyond a few years in a mortgage, as banks push for loans which have to be refinanced quickly to avoid financial penalties? This way, banks get your monthly payments and have to yield very little equity before the loan is renewed or sold to another vendor, at which point the bank receives the remainder of the money beyond the smidgen of equity they have yielded to the borrower. It’s almost like printing money. And we bailed these guys out, why?

In addition, my “financial advisor” pointed out that in order to refinance, if you obtain an new loan for the exact amount to payoff the existing mortgage you still have to suck out more equity because with closing costs, points, new mortgage title insurance, et cetera. You are going to end up borrowing an additional four to seven thousand dollars more just to get out of the old deal, not including any fees for pre-payment penalties. So, often times people are just stuck because they don’t have sufficient equity to refinance, or the cash reserve to refinance out of the deal (especially with the 80/20 deals that were so popular in the early 2000s).