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Option ARMs Are The Optimal Loans
September 21st, 2007 categories: Tampa Real Estate, News on Interest Rates
Are you kidding me? For whom? Well according to some professors at NYU and Columbia, the option ARM really is the best kind of mortgage for both lenders and borrowers. (This of course in a perfect world.) From a Business Week article I just read:
The main points are as follows:
- The option to pay less than owed is good for people with self-control and especially good for folks with fluctuating incomes (sounds familiar). Pay less when income is in the tank and then catch up when sales are good. And lenders like it because they don’t have to foreclose as much on people who do fall behind, a costly process.
- The floating rate is best for lenders because they’d prefer to have the defaults during periods of higher rates, when they have better options of re-investing the monies obtained through disposing of foreclosed properties. Defaults on ARMs are more likely when rates go up.
- The optimal loan would not allow re-financing because lenders provide borrowers a much better rate knowing that they will profit on the loan through its term.
But the good professors note that the optimal loan assumes borrowers are rational and will do what is in their best interest. Therein lies the problem. While I’m sure there are many borrowers who have used these things wisely and to their advantage, most borrowers who use option ARMs are irrational and don’t care about their best interest. They need that home now, no matter the cost down the road. They get hooked on the low rate, make the below minimum payment, pile on the debt, wait for the reset, and blame someone else for their problems when they see the new payment.
So the professors recommend education. Says one of the professors:
“Obviously people are to some extent irrational. But if you want to ban this type of contract, you should really weigh the benefits and the costs. How much could you educate people? Make people understand them. Provide them with software. Make a federal law that requires the lender to reveal what this contract is about.”
Never underestimate the irrationality of someone borrowing money. Through education, you may be able to make option ARMs work for more people, but you’ll always have plenty of irrational borrowers. Maybe an IQ test is in order? Hit a certain number and you qualify for an option ARM? Just a thought.
5 Responses to “Option ARMs Are The Optimal Loans”
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Lenny, you are absolutely correct on this topic.These Option arms are to complex for most people to understand. I understand the loan completely and I would never have one or recommend it to a client. These loans have only allowed borrowers to purchase homes that they cannot afford. Sometimes I think home sales are getting close to car sales in the since that people do not care what the total financed amount is, as long as the monthly payment fits.
Craig,
Thanks for the input. Since you’re in the business, have you never had a client that would benefit from this kind of loan? I know that the motivation for most borrowers who sign up for these is the low payments, not the option. But in the right hands, can’t this loan be good for certain situations?
I think it’s ok in a situation of an investor looking to minimize his monthly expenses while perhaps rehabing a home with
the hopes of selling it within the year. Also, this type of loan would work best if the existing real estate market were appreciating.
Again, it all has to do with understanding the costs of doing the loan which may include prepayment penalties and Monthly adjustments to the payment.
Anyone who recently structured a loan scenario based on gaining equity through appreciation may have to wait quite a while for results. Thanks again.
[…] FHA Secure lets borrowers who have a non-FHA insured ARM, whether current or delinquent on payments, refinance into a FHA insured mortgage. Homeowners who are delinquent on payments must be delinquent due to the reset of the ARM, or the recasting of an Option ARM. […]