Adjustable Rate Mortgages: Did you just get the willies?

February 3, 2011

Before I started working for the Bosses, if I heard anything about an adjustable rate mortgage (ARM),  I thought of a man in a cheap suit with slicked back greasy hair pushing a little old lady to sign on the dotted line.  She’s saying,  “Are, are you sure it’s safe?” and he’s like, “Sign it lady, or else,” while motioning his finger across his throat.  But over the years, I’ve heard the Bosses talk about clients getting ARMs.  And they talk about it using pleasant, respectable voices.  Neither one of them have started letting their hair get greasy either.  It’s time I get to the bottom of this.

Adjustable Rate Mortgages:  What You Need to Know and What to Tell Your Boyfriend

An Interview with Chad Helmcamp

Just the Assistant:  First thing’s first…Are Adjustable Rate Mortgages the work of the Devil, yes or no?

Boss:  No.  They are totally not a work of the Devil.  They are fantastic products for the right client.

JA:  We’ll get into who the right client is later.  But for now, why do ARMs have such a bad rap?

Boss:  Because they were sold to the wrong clients.  Over the last five to ten years, sub-prime products were created for people who had less than perfect credit.  And ARMs were sold to people who were not as financially sophisticated as they probably should have been.  They didn’t fully understand what they were or how they worked.

JA:  Okay then, what are they, and how do they work?

Boss:  An Adjustable Rate Mortgage is exactly what you’d think – an interest rate that adjusts.  There are all different kinds.  You can get a three-year ARM, a five-year ARM, seven-year or ten-year.

So let’s look at a five-year ARM – a 5/1 ARM is what we’d call it.  That means the interest rate on that loan will stay the same for the first five years.  And the 1 means that  the loan can adjust once per year starting in year six.

Then there are caps.  Every ARM has caps.  Let’s look at that same 5/1 ARM and say its cap looks like this:

5/2/5

Here’s what those numbers mean.  The first five means that the most this rate could possibly adjust in the first year of adjustment is 5%.  (Remember, the first year it adjusts is year six).  So in year six, it is possible that the rate could increase by 5%.

The next number, the 2, means that the most that interest rate could adjust after the first year of adjusting is 2% per year.

However, the last number, the 5, is the lifetime cap on how much the interest rate can adjust.  That is the most it can ever go up, no matter what.

So let’s say you got a 5/1 ARM, and the caps are what we mentioned above – 5/2/5.  Here’s what that could look like:

You get your loan at an interest rate of, let’s say, 4.5%.  For five years, your rate is 4.5%…period.

On year six, it could go up or down.  Let’s say it goes up 1%.  Now you are at 5.5%.

The year after that, it could adjust up to 2% – so you could go lower than 5.5% or it could go to 7.5% at that time.

But no matter what, that interest rate will never go above 9.5%.

[Note:  But here’s what we need to understand, if you come to my bosses and tell them you’d like to buy a home and live there for the next 15 years, or if you say you have no clue what your plans are, they aren’t going to recommend this type of loan to you anyway.  Why?  Because from what we’ve learned above, it doesn’t make sense to get this type of loan unless you have a pretty good idea of what the next seven or so years look like for you.]

Boss (still talking):  Then you look at whether you have LIBOR ARM or a treasury ARM…blah blah blah…talkingtalkingtalking…Every ARM has a margin…blah blah blah…numbers numbers numbers…

[I actually stopped typing at this point.  I’ve told you plenty of times, I don’t understand this industry.  I don’t know what other people on our team do, I don’t know what a title company is, and I don’t know what HUD stands for.  But with these things I at least have some knowledge about them.  Like with our team members, I at least know, “Oh that’s Shelley and she sits at that desk and she talks to clients on the phone.” With a HUD, I at least know it’s a document with lots of lines and numbers and people have to sign it.  And with the title company, I at least know…well, I actually don’t know anything about title companies.  But I almost wanted to cry when Chad started talking about margins and indexes.  I don’t know if I’ve ever understood anything less in my life.  I also don’t know if I’ve ever heard Chad so passionate.

In a way I’m flattered that he thought I’d understand.  But in another way I’m wondering if he needs to go to therapy along with James and the flowchart nonsense.]

Boss (starting to sound like a mad scientist):  Numbers…numbers….talking…index…You know?  You know what I mean?

JA:  Mmm.

Boss:  Christina?  I didn’t hear you typing any of that?

JA:  Mmm. Eh?

Boss:  Christina?

JA:  Hey, maybe I could just tell people they can call you if they’d like to hear more about that part?  That bit about treasuries?

Boss (deflated):  Okay, sounds good.

JA:  So, who would want an ARM?

Boss:  The ideal client is someone who knows what their future looks like.  For example, let’s say you work for Exxon Mobil and Exxon transfers you to another part of the country for a two to four year project.  And after that, you plan to move back home. It wouldn’t make sense for you to pay a higher interest rate on a 30 year fixed rate mortgage.  But, a five-year ARM would be a great product for you because you only plan to live there a few years, and the ARM will provide you with a lower interest rate for the first five years.  ARM interest rates can be anywhere from a half to a full percent lower than fixed rate products.

Or let’s say you already own a home, but only plan to live there a few more years before moving.  You could refinance your current mortgage into an ARM and save money on interest for the next few years until you move.

JA:  So what’s the risk?

Boss:  The risk is that nobody can predict the future.  Let’s take that same person from Exxon.  What if they decide to stay where they’ve been temporarily transferred?  The mortgage rate could go up and the payment could get too expensive.  However, before the ARM would reach the sixth year, we could look at refinancing the mortgage to a fixed rate product at that time.

JA:  What are the benefits?

Boss:  You pay less interest.

JA:  Okay, you gave some pretty good relationship advice last time we talked.  Let’s get some more scoop.  Say you’re a girl about to buy a first house and you aren’t sure how long you’ll live there.  Is it a good idea to get an ARM, and should you tell your boyfriend so that he knows you are the type of girl that keeps her options open?

Boss:  Let me start by saying I am very conservative.  If a girl came to me wanting a mortgage and she was unsure about her future, I would recommend a fixed rate product.  I never want to put someone in the wrong situation, because nobody wins that way.  Quite honestly, I would tell her to get a fixed rate mortgage, then let the guy know “I’ve got control of my situation; I don’t need you.”

JA:  That’ll tell ‘em!  Okay, what if you’re the boy and you know an ARM is right for you, do you think telling your girlfriend you’re getting an ARM will make her think you are more fiscally savvy and therefore she’d be more likely to say yes if you pop the question?

Boss (laughing):  Without a doubt.  Absolutely.

Just the Assistant:  Sounds great, Boss.  Now go answer all those phone calls!