For your consideration: Our observations regarding What's holding back the housing market?

For your consideration: Our observations regarding What's holding back the housing market?

In Defense of ARMs They're Neither 'Evil' Nor 'Toxic'

Keith Gumbinger

In Defense of ARMs
They're Neither 'Evil' Nor 'Toxic'

Introduction, and a few notes. Much of this four-part article was written in the wake of the housing market crash, but the arguments and facts here remain true even now. ARMs have an important role in the housing market landscape, and in certain market conditions such as those seen today, many potential homebuyers (and even some homeowners) may find themselves needing to consider an ARM instead of a fixed-rate mortgage.

It took a number of years, but the mortgage and housing crisis of the late aughts and early twenty-teens finally reached an inevitable conclusion. During those difficult times, mortgage shoppers were told all too often that Adjustable Rate Mortgages (ARMs) were either the cause of -- or at the heart of -- the housing market's failings, and put borrowers and lenders alike out on the street.

At the time, those claims had rattled their way across the political landscape as well, and the newly-formed Consumer Financial Protection Bureau for a time even considering banning all but "plain vanilla" mortgage products. As ARMs present different risks than do fixed-rate mortgages it's a safe bet that at least certain ARMs wouldn't have been included in any list of approved "vanilla" products.

However, arguments that ARMs are "evil" or "toxic" simply aren't supported by the facts. While it's true that most subprime mortgage products were ARMs and had a spectacular record of failure, and that even some 'prime' ARMs failed as well, it's also true that many ARMs didn't fail, and so may have even provided tremendous value to their holders.

It's also a fact that ARMs, in varying forms, had been a part of the residential mortgage marketplace for more than a quarter century at that point, and have been around nearly 40 years today. A mortgage product with this long of a history can't be all bad, or ARMs would have disappeared from the market. Certain varieties of ARMs -- even old standbys like the traditional one-year ARM -- have faded out the marketplace over time as consumers showed preference for other choices. Like every financial instrument, ARMs not applicable for everyone, or for every circumstance, nor do they always provide value to those who choose them.

It's important to note that ARMs were born of a need brought on by high interest rates. As they were developed, ARMs were based on the premise that borrower and lender alike should share the risks in an ever-changing interest rate climate. In exchange for accepting such risks, the borrower would benefit from a somewhat lower starting rate for a time, plus a chance at a lower interest rate in the future, and possibly lower interest rates which might persist for years. This is an important qualifier that you'll want to remember for later in this discussion.

The Product, or the Borrower?

While the forensics into the failure of certain ARMs went on for years, a distinction which needs to be made between the product itself and how it is or was utilized.

Suppose one needs to buy a vehicle. There are lots of choices, and all will get you from point A to point B. What type should one get? A buyer must decide what kind of vehicle best suits his or her needs, whether it is a sports car or a dump truck. It goes without saying that the two are meant for different purposes and aren't interchangeable, and a buyer selecting the wrong one will find an ill fit for their needs. This is also the case with financial products, including mortgages, which were developed to address certain time frames, needs and goals.

The oversimplified point is that some, if not many, of the problems with ARMs were not caused by the product, but rather by how it was applied relative to the user's needs or wants.

It's also worth noting that the sellers (salespeople) at our metaphorical car lot are interested in selling you something and will try to present you with as many choices as possible in order to make the sale. They can't make a living if they don't make sales, and for the most part, their role usually isn't to help you decide what kind of vehicle is right for you.

That said, we have always agreed that, if an ARM or any other mortgage borrower failed out of their loan due to circumstances beyond their control -- malfeasance, steering, predatory lending practices, whatever -- then let's expose and, if warranted, prosecute those bad mortgage actors to the fullest extent of the law. Conversely, to look to overly restrict or even ban access to a product which has proven to be helpful and useful to many hundreds of thousands - perhaps millions - of borrowers probably isn't the right solution.. Why penalize all borrowers, now and forever, for the failings of some of yesterday's? It just doesn't make sense.

Thankfully, ARMs weren't banned from the market. However, the Qualified Mortgage standards did ban some risky features that were overlaid onto ARMs, That's not to say things such as interest-only payments can't exist on ARMs; they can, but such ARMs can't be sold to Fannie Mae or Freddie Mac, and require the lender to accept and manage any risks and liabilities that might arise.

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