April 9, 2010
Adjustable Rate Mortgages Wrongfully Accused
By Jack Pritchard, Refinance.com
In the frantic search for scapegoats to blame for the housing crisis of the last two years, Adjustable Rate
Mortgages (ARMs) have been a favorite target. Only sub-prime lending, mortgage-backed securities
and credit default swaps have been more vilified by the media. We have all seen stories where the first
adjustment came, the house payment increased beyond the homeowner’s ability to pay and foreclosure
took hold with all the punishing vengeance of a medieval plague.
Is the ARM really to blame? Is the housing crisis a pandemic of predatory lending, or are borrowers to
blame for exuberantly rushing to take out loans they neither understood nor legitimately could afford?
To be sure, mortgage lenders often took advantage of the premiums they could make by selling the
borrower on the benefits of a low teaser rate for the first three years. And many borrowers made foolish
choices. But ARMs in general were not the problem. Even in today’s economic mess, ARMs have a
legitimate and essential place in the range of options available to prospective homebuyers.
An ARM is simply a mortgage loan whose interest rate adjusts, usually once a year, to a few
percentage-points spread over common bank industry indexes that measure costs of short-term
borrowing, often the London Interbank Offered Rate or the yield on short-term Treasury debt. Some
ARM loans are offered with fixed interest rates in their early years and caps on changes to their interest
rates once the fixed-rate period concludes. A “five-one 4.5% ARM” is going to be fixed at 4.5% for
five years, and then adjust up or down once a year. If the loan’s adjustment is capped at 1%, it means
that even if Libor leaps by several percentage points, the ARM’s interest rate won’t rise past 5.5% in
ARMs first became available in the U.S. in 1959. The Wisconsin state legislature approved their use as
a way to help savings-and-loans stru