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It’s Because of the ARM!

Posted February 10, 2010 by Matthew Denton

California homeowners have something to reveal to us.

We’re all aware of California’s real estate market stats that come in crashing month by month. Now, a survey by the California Association of Realtors reveals that the adverse adjustments of monthly mortgage obligations have forced 67 percent of home sellers to put their homes in the market last year.

C.A.R. President Steve Goddard explains, “Tighter underwriting standards and a decline in equity continued to impact the market in 2009. Many homeowners chose to sell last year because their adjustable-rate mortgage reset at the same time home prices were experiencing an unprecedented decline, leaving them with little equity and difficulty in qualifying for a refinance. Sellers responded to the challenges of the housing market in 2009 by choosing to work with realtors for guidance and assistance in navigating the complex market.”

California has one of the most creative mortgage tools in the country and lenders have earned so much from their innovation. It was a wise step at taming the high cost of homes in the state. The Union Tribune reports that five years ago in the state, “Nearly 83 percent of new home buyers in the county used adjustable rate mortgages in June 2005, an all-time high representing about 4,700 homebuyers. Nearly 63 percent of refinancings used adjustable rates, down just slightly from the record-setting 65 percent in May.”

The offers were tempting. Who wouldn’t want a mortgage that could lower their monthly payment by almost $90 compared to a fixed rate loan? Some were too eager to have $10,000 more in home equity in the first five years of their mortgage, thinking that they’d be selling their homes in a short time. But the crisis erupted and there was no way to recover.

A good research that shows the dangers of ARM and the even more dangerous hybrid loans was written by Anthony Pennington-Cross and Giang Ho of the Fed in St. Louis. They conclude, “Moreover, the time period when the loan converts from a fixed to adjustable rate is associated with a dramatic and temporary increase in prepayments and a modest and temporary increase in defaults… By design hybrids subject borrowers to payment shocks when interest rates rise or when an initial rate teaser is phased out. Hybrids are sensitive to these payment shocks…As a result, in an increasing interest rate environment we should expect to see elevated rates of default and prepayment in the subprime mortgage market.”

No wonder the housing inventory in California won’t return to normal levels.
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