Tuesday, December 19, 2006

A Farewell To ARMs?

As we enter the information age, it is very easy for anyone to pick up a newspaper or browse the internet to find information on mortgages. And given that there are so many types of loans available, the uninformed can easily get confused. So it is the responsibility of loan officers and writers to provide clear and precise information to aid borrowers in determining the best loan program for their given situation.

Unfortunately, it is too often that readers are misinformed. I read an article at the end of 2005 in the Washington Post in which the author mixed the concepts of an Interest Only ARM (adjustable rate mortgage) and that of an Option ARM and used that to justify why all such ARMs are bad. I wrote to her and mentioned that she did a disservice to the readers by combining these two types of loans. There are many instances where an Option ARM is not the right choice, but an Interest Only ARM is perfect. But the author practically scares off anyone who had looked at either choice.

I read an article within the last week (I wish I’d bookmarked it for reference) where the author, who is an alleged renowned financial guru, advised that no one ever select an ARM. My first reaction was, “how did this guy obtain credentials as a guru?”!! Granted, the gap between ARMs and FRMs (fixed rate mortgages) is not much right now, but that does not mean you exclude ARMs. One still has to consider the situation. In June 2004 I closed a mortgage for a buyer, a captain in the US Army who had just returned from a tour of duty in Afghanistan. Here’s how our conversation went a month earlier as we set up his loan:


Tchaka: Captain, how long do you intend to live in this house?

Captain: My tour in DC is for 36 months and then we’ll move to another location.

Tchaka: What’s the chance you’ll retain this home as an investment property?

Captain: Zero.

Tchaka: Well that’s easy, we’re getting a 3-year ARM!

Note: For those in the business, 3-year ARMs were lower than 5-year ones back at that time.

Putting the Captain in a fixed rate mortgage would have given him a rate about 1% higher with no benefit to him. Given that same scenario today, the variance might only be 0.25%, but still, why not give him the lower rate since he knows exactly what his intentions are when he moves?


Here’s a very brief explanation of 3 types of ARMs:

  1. Fully-Amortizing ARM: this is an ARM that has a fixed rate for a specific period of time then adjusts (usually once per year) and payments go towards principle and interest.

  2. Interest-Only ARM: this is identical to the fully amortizing ARM except that no payments are made towards principle.

  3. Option-ARM: this is a type of ARM that provides up to 4 types of payments, i) 15-year fully-amortized, ii) 30-year fully-amortized, iii) Interest Only (based on a 30-year amortization), and iv) Minimum Payment - a payment often lower than interest-only, thus potentially resulting in negative amortization.
- Tchaka Owen