Adjustable rate mortgages have both advantages and disadvantages. An option for both conventional and government loan programs, adjustable rate mortgages – commonly referred to as ARMs – offer below-market interest when standard rates are higher. But upfront lower interest does not remain a constant, increasing over time instead. Because of these “balloon” payments, ARMs are said to have been a force behind the housing market crash in 2007.
Announced by the Consumer Financial Protection Bureau on January 10, 2012, lending for ARMs is expected to go through multiple changes over the next 12 months. New standards are an effort to avoid another mortgage bubble and resulting rampant foreclosures, and essentially, the changes make qualifying for an ARM far more difficult than before.
The “ability to pay” rule is, perhaps, the most significant change, and one designed to prevent borrowers from taking on mortgages they can no longer afford in the future. Lenders, once the new standards go into effect in January 2014, must decide whether a borrower can pay both the initial and fully-indexed interest rates. Such a practice is already used by some lenders but is not an industry standard.
The expected ramifications include stiffer qualifications for ARMs. Unlike in the pre-crash years of the 2000s, lenders likely will not use ARMs as a “fall back” loan for those with low or poor credit. Aside from this aspect, the loan type had other benefits for the lender – particularly higher profits once rates began increasing.
But, mortgage analysts don’t consider the new measures a blanket cure for the industry. Instead, as the fully-indexed rate is not the cap on an ARM, payments have potential to increase beyond this point – and, essentially, spur another crash resulting in more foreclosures. In a statement, Stu Feldstein, president at SMR Research, told the press: “It could happen now more than in the past because we’re starting out with rates that are incredibly low.”