The iron grip of ARMs on California real estate

Hi,

I get the impression that you are completely condemning ARMs as a financing tool, in which case I strongly disagree.

There are different types of ARM loans. This essay, as with several other discussions of ARMs I have read in recent years, seems to imply that all ARMs start off with an artificially low interest rate that inevitably has to increase dramatically at some point in the future. To me, this type of loan is just one subcategory of ARMs, with variations such as a structured graduated payment loan or a loan with an extended ‘teaser’ rate which is what you appear to be talking about in this article.

A ‘traditional’ ARM might start off with a slightly reduced teaser rate for the 1st six months or so, and then change to what I call the ‘real rate’ (the index plus the margin) for the remainder of the loan term. The teaser period ‘savings’ can be easily evaluated by applying the short term savings during the teaser period to the total up-front cost of acquiring the loan (points, appraisal, misc. loan fees, etc.) when comparing one loan product to another when determining which type of loan is best suited for a borrower at that time.

A traditional ARM should always be considered during periods of the interest rate cycle when interest rates on fixed rate mortgages are relatively high. The financial decision in choosing a fixed or an ARM in that environment comes down to making an educated guess as to which loan will have the lowest AVERAGE interest rate over the term of the loan. The ARM interest rate will go up at times, but they also go down at times, often by a lot.

Borrowers who chose competitively priced ARMs during high interest cycles since the mid 1980s have averaged much lower interest rates than if they had chosen the fixed rate loan available at that time. At the same time, I believe that when fixed rate loans are available at interest rates that are relatively low by historical comparison, a borrower should always get the fixed rate loan.

Choosing an ARM under the conditions I mentioned always assumes that the borrower is financially and psychologically able to handle the rate increases during the up cycles. I have found, however, that once someone has experienced the joys of having one’s interest rate and monthly payment go down substantially for an extended period, the increase periods are much more acceptable.

As an apartment investor, I have had many ARM loans on investment properties over the past 30 years. A far bigger and more frustrating problem with these loans has been hitting the minimum floor interest rates rather than the periods of higher rates. I have never had an ARM get anywhere near the cap rate.

Thanks,

Tim Carrico