http://business.bostonherald.com/businessNews/view.bg?articleid=159159

heh.  for once, I dont think this is bushs fault.

still, I do hope he gets the credit for it.

Yeah I agree with that. The ARMs are going to cause big problems in conjunction with the housing market collapsing. We will see massive bank failures. Of course the bank CEOs will give themselves big fat golden parachutes as the bank collapses, and the bankruptcy judges will approve it all before driving their ferraris to their luxury mansions.

If my bank collapses, does that mean I no longer have to pay my fixed rate mortgage?  Because that would rock!

How badly does a spike in the interest rate really affect the monthly payment? By my calculations, not all that criminally.

Say that again when your interest rate jumps 6% and your principle is $300K.

How the hell would it jump 6%?

Anyone remember the early 80s?

Sure - interest rates hit 18% just as I signed the contract on a flat and was made redundant

"How the hell would it jump 6%?"


do you know what ARM contracts are?

Hmm.  No, if your bank starts to collapse, they may call your loan.  Do you have a spare $100,000 to pay that off?

Hmm again.  If you DO have that spare $100,000, where are you keeping it?

If it's in a mattress, it's depreciating.  If it's NOT in a mattress, then THAT bank/stock/mutual fund may collapse too.

> do you know what ARM contracts are?

There will be clauses in there which they can make effective and change the terms if situations demand.

"do you know what ARM contracts are?"

I know what annuity loans are. Fixed margin plus six months' worth of the interbank offered rate (I guess the US equivalent is the Federal Reserve rate?).

Or do you mean to tell me that in the US, the bank gets to change the interest rate to whatever it chooses at any point in time?

"No, if your bank starts to collapse, they may call your loan."

Actually, no, they may not.

OF COURSE it's Bush's fault!  He inherited a balanced budget, historically low interest rates, a well greased economy.  He used his Presidency to raise the budget deficit BACK to $300 Billion Dollars (something that took ALL THE PRESIDENTS UP TO REAGAN to do before -- he did it in 5 years!)

While supporting an economic policy that said No Inflation, he did the most inflationary thing possible.  And borrowed heavily to do it.  Thus raising interest rates, thus putting the brakes on the housing market, thus taking us from a very stable and reliable situation into one that depends on continued borrowing from the Chinese/Japanese/Germans to continue.

Sure, while you're spending $300 billion a year, pumping up an economy that didn't need it, it seems times are 'flush'.  Until you can't borrow any more.

Well, Flasher, that's true, you're bank can't call your loan.  However, if you get laid off, and can't make your house payment, they may take your house.

I believe that's what happened in 1929.

Yup.  An ARM (Adjustable Rate Mortgage) has a 'floating' interest rate.  Most of them have a limit on how high they can 'float', though.  And a limit on how fast they can 'float' to get there.

Last ARM I did started at 4%, and could go to 8% in 2%/year increments.  Can you say "double your house payments"?

At least, there's no risk of loss of capital. Only inflation shaves off whatever it can.
Under the mattress may be a good option :)

If banks collapse usually the Fed (or the equivalent body) would intervene and request banks in good shape to take the loan. We would be paying whatever we would've had to had the original bank hadn't collapsed.

SaveTheHubble - That was a super post about Bush's fault. What do you think about Jimmy Carter? Inflation then was something no one could've done anything about.

Sigh.  If I'm a bank, and I hold 100 house loans, and 20% of them default (because of unemployment) -- who am I going to sell those houses to to get back my liquidity?

I drop the prices of those houses to what people can afford, that's what.  Yes, there's "loss of capital".

"Or do you mean to tell me that in the US, the bank gets to change the interest rate to whatever it chooses at any point in time?"

Yes.  With very few restrictions.

>How badly does a spike in the interest rate really affect the monthly payment?
About half of mortgages written today are "interest only" and of those, about half aren't actually paying the interest needed, so they've got some serious negative amortizaion going on. That means that one's mortgage balance goes up several hundred dollars per month.

This fall to next spring there is about $1.5 Trillion in mortgages that go from "interest only" to "principle plus interest." Some folks will be seeing 100% to 300% increases in monthly payments.

Also scary are the "Option ARMs." A lot of mortgage brokers are getting kickbacks from the lenders for signing suckers up with loans so complicated that the average homeowner doesn't understand what they cost. And mortgage companies use brokers to shield them from lawsuits.
http://www.businessweek.com/magazine/content/06_37/b4000001.htm 
http://www.latimes.com/classified/realestate/buying/financing/la-re-harney9apr09,0,6345834.story?coll=la-class-realestate-finance 
http://www.acorn.org/index.php?id=9412&tx_ttnews[tt_news]=18757&tx_ttnews[backPid]=8360&cHash=17cbeeb38b

The "kill inflation" theme STARTED with Jimmy Carter's putting Paul Volker in place in the Fed.  He RAISED INTEREST RATES to like 20% to kill inflation.  It took several years of 'hardship' to stop the inflationary cycle, where people would borrow money today to pay back tomorrow with 'cheaper' inflated dollars.

Reagan inherited that, and kept Volker on, and kept the 'no inflation' monetary policy.  But THEN began the Reagan military buildup, and the steady increase in the deficit.  Greenspan, when he joined the Fed, maintained the 'kill inflation' monetary policy.

The "kill inflation" monetary policy is a good one.  But if you deficit spend at the same time, you turn your country from one that has cash reserves and flexibility into one that owes money to the rest of the world and depends on their good will.

"I believe that's what happened in 1929."

What happened in 1929 is that lots and lots of people had invested in the stock market, which drove prices beyond reasonable levels (i.e. the market capitalization of companies was nowhere near an adequate representation of their value). When the bubble ran out of money input, the market crashed, lots of capitalization disappeared into thin air and people lost investments. Because of this everyone got too scared to spend money on anything. That's what caused the Great Depression - lack of spending, not the stock market crash itself.

But yeah, I suppose foreclosures came as a result of businesses shutting down and owners/employees being unable to meet mortgage payments.

"Yup.  An ARM (Adjustable Rate Mortgage) has a 'floating' interest rate."

Jesus fuck. Who'd sign away their life to a bank like that?

"If banks collapse usually the Fed (or the equivalent body) would intervene and request banks in good shape to take the loan. We would be paying whatever we would've had to had the original bank hadn't collapsed."

If a credit institution goes bankrupt, the bankrupcy manager sells off assets, and yes, loans would be sold to other credit institutions.

"Jesus fuck. Who'd sign away their life to a bank like that?"

Enough retards to make it a standard practice in the US, to the point that getting any OTHER sort of (more sane) deal is exponentially harder than it should be.

"About half of mortgages written today are "interest only""

OK, the local equivalent of that would be a break from payment - you can ask a bank to skip the principal payment this month (if you've got a new baby for example) and only pay the interest. But there's a limit on how much you can do that (8 times over the course of a contract, I think). From what you're saying it seems like people are getting into mortgages they can't afford - that could not happen here; by law all your loan payments cannot be more than a percentage of your net monthly income (30% base, 40% if you earn about 1.5 the national average, 50% if you earn twice that). Of course you can end up with a loss of income, but at least people think long and hard before they get a mortgage in the first place.

During the S&L meltdown of the 80s, the S&Ls with lots of foreclosures just held onto the assets. They didn't dump them on the market because they were trying to keep the value of their assets higher. It wasn't until the S&Ls ended up in liquidation themselves that massive amounts of properties ended up on the market, driving prices down. Some of the neighborhoods here in Denver took 80% devaluations in that timeframe, and didn't recover in price until 2000 and later.

Nowadays, banks package up loans and sell them off as fast as possible, so they aren't holding onto them when the music stops. MBS - mortgage backed securities - are the new way to shovel those hot potatoes into the hands of new suckers.

"From what you're saying it seems like people are getting into mortgages they can't afford"

Yes, exactly.  And it's not just ARMs and interest-only; there are a bazillion products out there, and while some of them are good ideas in particular circumstances, most of them are designed to screw the consumer.

As an example, you can get a mortgage that has a fixed rate for 5 years, and then is variable after that.  If you are planning on refinancing or moving after 5 years (which is already a dodgy proposition, but maybe it makes sense in your situation) this coudl work out for you.  For everyone else, you're getting screwed after 5 years.

Pedant's corner: principAL.

Principle's generally found some distance away from banks.

>> Jesus fuck. Who'd sign away their life to a bank like that? <<

Lots of people without much financial education.

ARMS *do* make sense in certain limited scenarios: You know that you'll be selling the house before the non-adjustable period ends; or you're fairly confident that interest rates will go down in 4 years.

The deal is, with interest rates about as low as they could go, they had no where to go but up.  So why would *anyone* sign up for an adjustable rate loan?  It just doesn't make sense.

Possibly because the deal looked good as it gave them what they wanted at a repayment level they can afford.

Problems arise when the interest rates go up or they lose their job or the roof falls in businesswise - leading to this - where the mortgagee will sell the property on the day to the highest bidder, take his equity and expenses then hand over the remainder (or a demand for the remainder) to the hapless ex-owner.

http://www.domain.com.au/Public/PropertyDetails.aspx?adid=2005974822

When I was house shopping, every other sentence from brokers was "An ARM would have a monthly payment of only..."

I asked several of them who the fuck would sign an ARM when interest rates were at record lows? They generally didn't answer.

But yes, getting info on a standard fixed rate mortgage was often difficult.

It's funny.  When the interest rates 'started up', ARM's became more popular.  You see, an ARM can be a percentage point or two (or more) lower than the equivalent fixed mortgage.

Yes, this has an appeal for the naive first time home buyer, it means they can "afford" (for now) a more up-scale home -- or afford to move at all into some neighborhood with good schools.

And in the last 10 years, and especially under Clinton, an ARM was a good deal.  They COULD have gone up, but didn't, and so you got that benefit of 3 or 4% below a 'fixed' rate for quite some time.

Now that interest rates are rising, those savings vanish, of course, and a house 'barely affordable' with an introductory ARM (at 30% of income, whatever qualification metric they used) becomes 'barely not affordable' when the rates rise.

It's funny.  Credit departements make their highest profits off of naive people who borrow to the hilt -- UNTIL the economy changes enough that those people default.  So the Credit Departements have an incentive to almost, but not quite, ruin their customers.  And only a little incentive to teach their customers how to avoid bankruptcy.

Payments on an ARM are lower than payments on a fixed mortgage.  As the next place rates are going in down not up -- economy is slowing, we've got two pauses out of the fed already -- the ARM makes a lot of sense right now.  Hell of  a lot more than it did when rates were at 2%.

*Now* an ARM may make sense (though remember we get a new Prez in two years, and he may think high interest rates are a good thing)

But when I bought the house interest rates were at 5% - how does an ARM make anysense at all then?

I'm feeling very snug and cozy in my 6.5 fixed, personally.

Here (Canada), we don't have ARMs, but we have variable-rate mortgages: the rate is some small, fixed amount higher than the Bank of Canada Rate (roughly equivalent to Federal Reserve Rate).  Mortgages with fixed rates, or some sort of rate insurance (option to lock in if rates go up) have generally been 1-2% higher than variable-rate.

During the past ~10 years, interest rates have been low, so variable-rate mortgages have been great.  They've also helped build the bubble here, since people have been able to buy in to expensive homes w/ very little down, have manageable payments, and then the increase in house prices has meant they've been able to build a ton of equity.  Everything's fine until the Bank of Canada starts raising rates... then we'll see some interesting times.

For us, the apartment we live in is paid off, and we have a variable-rate mortgage on a rental property (which is the only situation where interest is deductible in Canada).  The rental probably won't lose its value in a crash, so maybe we'll actually be able to afford a house if there is a crash.

Ward, your adjustible rate sounds v. similar to our ARM with similar short term and eventual results.

Steel, it all depends on the economy and the individuals outlook and circumtance, but yes 5 seems low and might be good to lock in.  As some have pointed out, if there is a dual deficit driven dollar collapse then 6-8% will seem cheap in hindsight.

muppet, Yup. There is something safe and secure about the fixed rate.  It's about personal comfort with a particular risk level. Paying that 30 year fix down early might be comforting too.

Efficient market theory would say that on average, over the long-term, the riskier variable/adjustable rate mortages are priced just right with respect to their more sure-footed fixed rated friends.

A 7% loan costs 75% more than a 5% one over a 30-year period. That leaves a lot of wiggle room for the 'stupidity' of an ARM.

[One is to be reminded here that the Central Bank of Japan's interest rate has been below 0.5% for much of the last 15 years. Following an asset appreciation bubble not unlike the US's/Canada's.]

The ARM isn't as bad as it sounds, if you get a decent one.  Since my wife was a lender at the time, we were able to get a good one.

The interest rate on my mortgage is capped at a certain percentage above the initial rate.  Currently I think that the highest it can go over the life of the contract is 15.5%, which is way more than it is now, but still way less than what my parents borrowed at in 1980.

There's also a limit to the size of the hikes.  It can only go up so much per year, so I don't get bent over too hard all at once because of an interest rate spike.  Right now property taxes are much more likely to bend me over, and they do just about every other year, taking $100 onto my payment every now and then.

We're all gonna die!!!!!!!!!!!!!!!!!!!!!!!!!!!

>> but still way less than what my parents borrowed at in 1980 <<

Dad had a 3.5% loan from the mid 1960s, and in 1980 the lenders were calling, begging for him to refinance. 
"What's the rate?"
"We've got a very reasonable 17.6% right now."
"{click}"

Did he ask what the rate was expecting to find something better?

"ARMS *do* make sense in certain limited scenarios: You know that you'll be selling the house before the non-adjustable period ends"

Most of the ARMs nowadays have steep pre-payment penalties. So you'd have to find a buyer willing to assume a prexisting ARM mortgage, or pay off the full value of the loan, which means not just the money you owe, but the interest you would have paid in the future.

Yep, the only reason we took a variable interest rate loan was the LACK of prepayment penalties - we were allowed to deposit and withdraw as much as we liked between 0 and 100% of a steadily reducing maximum amount (was $250,000 is now I think $50,000). We got the debt down to $500 at one stage but it jumped when we had to buy a replacement car.

Prepayment penalties OTOH festooned the alternative fixed interest loans going at the time.