Adjusting Mortgages

A new regulation comes into force on Jan. 10 next year requiring lenders to assess a borrower’s ability to repay most types of residential mortgages. To obtain a “Qualified Mortgage” designation and shield an originator from some consumer lawsuits, exotic loan options like negative amortization, interest-only periods and balloon loans cannot be employed. Although simple adjustable-rate mortgages can achieve the designation, they must be underwritten to ensure that the borrower can afford the highest possible interest rate he or she would face in the first five years of the loan. ================= Adjusting mortgages Rehab needed for U.S. 30-year mortgage habit 11 November 2013 | By Daniel Indiviglio Email Comment Save . America needs to kick its addiction to the 30-year fixed-rate mortgage. This method of financing home loans has its place – mostly when interest rates are stable. But it’s cumbersome when rates fall and can be a real problem when they rise. Floating-rate mortgages are better suited to all environments, yet neither consumers nor regulators seem fond of them. These obstacles risk a shock to the recovering U.S. housing market. Arranging a mortgage with payments spread equally over 360 months has been a consumer favorite since the Great Depression. Floating-rate loans – or, as they’re called in the United States, adjustable-rate mortgages (ARMs) – have enjoyed only occasional spurts of popularity. They have generally accounted for no more than a third of new home loans since 1990, according to the Federal Reserve. That makes the U.S. system an anomaly. Most countries use shorter-term, floating-rate products. In the UK, 10 and 15-year loans with interest rates that adjust with the market are the norm – and at around 64 percent the British home ownership rate is similar to that in the United States. The financial crisis dealt a severe blow to borrowers’ perception of ARMs. That’s because bankers added dangerous features like interest-only payments and even the option for people to choose how much to repay early on. That enticed those who otherwise might not have been able to afford a mortgage, resulting in a raft of foreclosures. Since then, adjustable-rate mortgages have accounted for less than 10 percent of new originations. That has left their fixed-rate brethren in an even more dominant position. Granted, borrowers can refinance as rates drop – and many have. But they have to pay to do so – a pain for them, but a boon for banks. Moreover, the cost of any U.S. fixed-rate mortgage bakes in a penalty for paying it back early, regardless of whether that happens. As a result, American mortgage costs are at least as high as those in Canada, which include explicit prepayment penalties, International Monetary Fund research determined in 2009. Cost isn’t the only factor that should make floating-rate loans more appealing to borrowers. Refinancing a fixed-rate loan requires requalifying for a new mortgage. That can be hard to do in a downturn for those who are earning less or whose home value declines. ARMs, on the other hand, reset automatically at set periods. But it’s when rates rise that floaters really come into their own – especially when, as now, they are expected to jump from unprecedented lows. Consumers might not at first appreciate the idea that the interest rate on ARMs will at some point go up. But that’s likely to happen for fixed-rate mortgages, too. Here’s how. The interest rate on a 30-year home loan is around 4.2 percent today. If over the next few years interest rates double, then a lender’s rising cost of capital may turn that investment into a dud (a thing that fails to work properly or is otherwise unsatisfactory or worthless). To make matters worse for investors in mortgages, rising rates may mean fewer people moving to a new home than is typical. That could leave them stuck with even more subpar investments. The obvious response would be for lenders to hike charges for fixed-rate loans from the start. Adjustable mortgages, on the other hand, are more flexible. That’s why two-thirds of borrowers chose them in 1994 as rates rose. That might be hard to replicate this time round. New regulations that kick in next year require lenders to ensure borrowers can afford the highest payment a floating-rate loan could require in its first five years. That sounds prudent, but the added workload may make borrowers even more wary of the product and lenders even less willing to provide it. If so, then the rising cost of fixed-rate loans may keep potential homebuyers on the sidelines. Unless borrowers and banks shrug off their ARM aversion, the ensuing lack of mortgage supply and demand could then have the knock-on effect of freezing or even driving down home prices. That would be a setback for America’s slowly improving economy. =============== =============