Joshua Plummer

I am in the mortgage business to make money...as a general rule of thumb, but I know the reason why I am successful, but not incredibly rich, is because I have a problem doing things for the pure motivation of money. I still am motivated every day to be the best mortgage professional I can be, I am motivated to create a good name for myself and to actually help people. I am motivated to provide a service, but to actually help my customers. Maybe I will never be rich because of it, but at least I can sleep at night. A fellow blogger on AR has once accused me of being unethical (although I think this was a ploy to sell poorly written books) but I like to think I have my customers' best interests in mind.

I mention this only because of something that happened to me this week. A client came to me, it was a referral from a new realtor that I just met and have just started working with. As in all new relationships, I want to shine, I want to show how good I am at my job and help this Realtor understand that working with me is like flying first class, but...as in many instances, things never go smoothly when you want them to.

This client had a decent credit score, but a little on the low side. She has a bankruptcy in her not so distant past, and while she has re-established credit, has not fully recovered from it. She has a good job, but with her debts, would only qualify only for a mortgage with about a $200 monthly payment. I don't know about the markets in your area, but around here that won't cover rent in many apartments. To make things worse, she is living with her parents, and wants to buy the house in order to rent it back to her ex-boyfriend. It appears the owner wants to sell, and the x is worried about a place to live.

I spend a few hours explaining all the reasons why she should not do this, but she has her mind set, and wants to consider a "stated income loan." I have heard stated income loans referred to as "liars loans" and with good reason. Now there are plenty of good reasons to use these loans, a self employed borrower who doesn't show much income is one good reason, a buyer with a husband who provides income, but can't qualify to be on the loan, even in some cases to stretch monthly income by a few percentage points to help qualify for a loan, but to straight out lie about it and furthermore to put yourself in a dangerous financial position is a horrible idea. I told her I couldn't help her and I actually turned down her business. While I could easily have gotten her approved for a "stated income loan" I knew in my heart it was a horrible idea for her. I found out within days that somebody was willing to do the loan for her and it made me sick.

We have heard a lot of flack and gripes lately about zero down mortgages and option arms, explaining that these might be a sign of impending doom and sky rocketing foreclosures, but when used properly, there is nothing wrong with those programs. It is my personal opinion that the single largest factor leading up to rising foreclosure rates, now and in the near future is the incredible amount of lying that is going on in order to obtain mortgages. Lying that is done in the form of a stated income loan. We as mortgage and Real Estate professionals have to put our clients well being, and the stability of our housing markets (and therefore our livelihoods) ahead of greed and immediate gratification. As the gatekeepers, we have a responsibility to do so.

Throughout the last couple years, adjustable rate mortgages have become a very popular option for American consumers. It has been suggested by some analysts that adjustable rate mortgages currently make up close to a trillion dollars of the country's outstanding mortgage debt. A large portion of these loans were originated in 2003 and 2004 during the height of the last refinance boom and are set to adjust or reset in the coming year. (if they haven't already) A recent article by Mark Davis of the Kansas City Star explains; "some estimates suggest when this occurs, a borrower's potential house payments will go up 5 percent, 15 percent, or even 25 percent in some cases." As property values across the country continue to decrease, some homeowners will be stuck with rising payments, but unable to refinance because of their home's depreciating value.

If you have an adjustable rate mortgage, or ARM there is no need to panic, but you need to learn what your options are. The most important thing is to understand how adjustable rate mortgages or ARM loans work.

First of all, every ARM loan has the same basic components: a start rate, a term, an index, a margin, a change date, and a cap (if you are lucky). The start rate is easy to explain, this is the rate your loan "starts" at when your mortgage begins. The start rate is usually fixed for a certain introductory period of time known as the term. While most ARM or adjustable rate mortgages are amortized over a 30 year period, the introductory period or term varies widely depending on the program. Typical ARM terms are 1, 3, or 5 years, but some introductory periods last as long as 10 years or as little as 1 month before they adjust. After the term of your start rate is complete, the ARM will adjust at the same time (often once per year) for the life of the loan...usually the duration of the 30 year period.

Now Things get a little more complicated for the average home owner. The interest rate of every adjustable rate mortgage is based on a financial index of some kind. Two of the most common indexes are the 1 year CMT and the 6 month LIBOR. The 1 year CMT or the constant maturity treasury index tracks weekly or monthly yields on U.S. treasury securities, and the LIBOR or London Interbank Offering Rate Index tracks the average interest rate on Euro-dollar deposits traded between London banks. The margin is how much money the bank is making on your loan. Typical margins range between 2-3%. Your interest rate is determined by adding the index and the margin together. So when your ARM adjusts on your change date, on the first year following your introductory period, you would calculate your new interest rate for the coming year by looking up the current index rate, and then adding your margin rate to it.

For example, if your loan was adjusting today, and was based on the CMT, you would look up the CMT in today's Wall Street Journal (about 5% currently) then you would add your margin to this number. (assume about 2.00%) This means your new rate today would be about 7% for the remainder of the year and the process would repeat itself at the same time next year. Your ARM loan may have a cap if you are lucky. A cap is a limit placed on an ARM loan that determines how much it can adjust from one year to the next and it also limits how far an ARM can adjust over the life of the loan as well. If you are lucky enough to have a cap on your loan, it usually means it can't adjust more than about 2% from year to year and no more than 5% or 6% over the entire life of the loan. Some adjustable rate mortgages have no cap at all.

According to the Mortgage Banker's Association application survey, for the week ending September 8, 2006, the current average contract rate for 30 year fixed mortgages is about 6.375%. As you can see from the example above consumers with adjustable rate mortgages can expect an interest rate around 7% as their ARM loans start to adjust and even higher in the coming years as rates continue their trend upward. Most experts are recommending, and we agree, that as rates continue to rise, so will prospective mortgage payments for consumers with adjustable rate mortgages. If you have an ARM, now is the time to consider refinancing it to a fixed rate mortgage.

STUDY WARNS OF PENDING "RATE SHOCK" FOR HOMEOWNERS

Predatory Lending has been a major concern lately, but law makers and watch groups have mostly concentrated their attention on predatory practices such as pre-payment penalties, excessive fees, high interest rates, flipping, excessive yield spread premiums and balloon payments. Until this year their has been very little recognition of the prevalence of adjustable rate mortgages in the subprime market. I consider the following very interesting: According to the ACORN study, "while ARM loans account for about 24 percent of all home loans nationwide...in 2005 ARMs made up 75 percent of all subprime loans, a huge increase from 1999 when only 50 percent of all mortgages were ARMs."

Why is this interesting? Well, many borrowers are forced into these sub-prime loans, often they are not even given the option of a conventional loan, or even a fixed rate sub-prime loan. The Acorn study suggests that "borrowers in the subprime market are often steered into ARMs without being given a choice and have little knowledge of how ARMs work or the risks associated with these loans...furthermore, Fannie Mae
and Freddie Mac have estimated that between one third and one half of all borrowers in subprime loans could have qualified for a lower cost mortgage." Many of these borrowers could have also qualified for an FHA
loan, since FHA has no minimum credit score requirement, but since many mortgage brokers aren't licensed to originate FHA loans, they rarely offer them to their borrowers.

Usually these sub-prime loans are zero-down mortgages and as stated earlier come standard with a pre-payment penalty. What this means for consumers is when their already high-interest ARM starts adjusting,(usually after a 2 year introductory period)their payments skyrocket, and they are unable to sell or refinance because they have little or no equity and the pre-payment penalty will cost them even more. Since they are only required to qualify for the mortgage based on the introductory payment, not the max payment, they often can't afford the higher mortgage, and with no way to sell, often are forced to lose
their home to foreclosure.

If this problem isn't bad enough by itself, the study, which surveyed data from 130 Metropolitan areas determined that in the 10 areas at greatest risk, including Detroit, MI Memphis, TN, Jackson, MS, McAllen,
TX, El Paso, TX, Laredo, TX, Brownsville, TX, Flint, MI, Springfield, IL, and Birmingham, AL, high-cost, Subprime Loans, represented more than two out of every five home purchase and refinance loans. Does anybody
notice a similarity about these communities...you don't have to be a rocket scientist, or a statistics geek to realize these are all predominantly minority communities. "Even when controlling for income,
minority borrowers were at a greater risk to receive a high cost loan than white borrowers."

The study concludes that "in far too many cases alternative mortgages are being sold to consumers who can only afford the initial lower-payments but will not be able to afford the higher payments that will come when the initial teaser rate period ends...Borrowers will have failed to build equity at this point meaning they won't be able to
refinance or sell...The result is damaged consumer credit, possible loss of home, increase defaults for lenders and in communities with large concentrations of these loans -more vacant homes." Why is it that many
metropolitan areas, minority neighborhoods are at a greater risk of rate shock and predatory lending practices? I used to think it had something to do with education, but education usually correlates with income in
these studies, and this study shows that "upper-income African Americans were at least 3 times more likely than upper-income whites to receive a high-cost refinance loan in 12 major metropolitan areas surveyed." In
the meantime, the only thing I can suggest is more education, and more community programs sponsored by banks to make sure that consumers are aware of the problem. Food for thought anyway.