Affordability Crisis Stimulates Borrowers’ Appetite for “Riskier” Lending Products — RISMedia

As the housing affordability crisis persists, aspiring homeowners have developed a greater appetite for riskier mortgage products that can ease the burden of rising expenses associated with buying a home.

This has been evident in the adjustable rate mortgage (ARM) market, as experts say they have seen a significant increase in their popularity with borrowers this year compared to 2021.

“The main reason they are becoming much more popular now is that they generally offer lower introductory rates than fixed rate mortgages,” says Jacob Channel, senior economist at LendingTree, who wrote an article. recent report showing that the number of ARM offered to its users more than tripled in the first half of 2022 compared to the same period last year, up 230%

Experts tell RISMedia that MRAs have made a significant comeback over the past decade.

According to Joel Kan, associate vice president of economic and industry forecasting for the Mortgage Bankers Association (MBA), the LendingTree report also points to a bigger trend in the lending industry.

Based on MBA data, the share of ARM applications has settled between 9% and 11% of all mortgage applications in recent months, compared to 3% in 2020 and 2021, when the refinance market exploded under record mortgage rates.

As mortgage rates jumped from 3% to nearly 6% in the first half of the year, Kan says the move to ARMs indicates borrowers are looking to stay competitive while keeping monthly payments relatively low.

Such is the case with mortgage broker Shant Banosian of Guaranteed Rate, who says he and his team have had more conversations about adjustable rate loans than they have had in a long time.

“It became sensible and strategic,” says Banosian. “We have a lot of these conversations, and we see that a lot of our customers are using products like seven-year and 10-year ARMs instead of using a 30-year fixed rate loan.”

This is mainly due to the increase in borrowing costs and house prices over the past two years. The share of ARMs in 2020 and 2021 was negligible compared to the boom that refinancing and traditional 30-year fixed rate lending experienced while mortgage rates were still at record highs.

That has changed significantly this year as potential buyers seek to borrow cheaper to stay in the market and compete, according to Banosian.

“A lot of people, especially first-time home buyers, won’t be staying in those homes for 20 or 30 years anyway,” he says. “The idea is to use the seven- or 10-year ARM if it makes sense and if it’s something you can be comfortable with. And if the opportunity arises, or if rates decline in the future, consider refinancing.

While ARMs have become more common this year than last, Channel says they still pale in comparison to fixed-rate mortgages, which still account for the lion’s share of purchases. LendingTree’s report indicates that nearly 11 30-year fixed rate mortgages are offered for every 30-year ARM.

“This means borrowers are still much more likely to be offered a fixed rate mortgage than an ARM,” Channel said in the report. “That said, around 41 fixed rate mortgages were offered for every variable rate mortgage in the first half of 2021, so the popularity gap is narrowing.”

Remember the accident

For those who remember the 2008 financial crisis and some of the factors that caused it, the rise of variable rate mortgages may bring mixed feelings.

At that time, ARMs accounted for 42% of all new mortgage originations before plummeting after the financial downturn. That’s not far off MBA data, which puts the peak share at 36% in March 2005.

The share has hovered around 10% or less from 2009 to 2021.

According to Rick Sharga, executive vice president of market intelligence for ATTOM Data Solutions, ARMs make sense for “the right kind of borrower and the right situation.”

“It’s important for borrowers to understand the potential risks of taking out an adjustable rate mortgage,” Sharga says.

They were a popular commodity before the housing market crash; however, many borrowers who had secured adjustable rate loans at the time due to their low introductory rates ended up defaulting when rates rose, resulting in a ripple effect that led to the world economy down.

Experts agree that today’s market has come a long way since the days of the 2008 crash, especially when it comes to lending standards and regulations surrounding ARMs.

“The lending standards and the environment in which these ARMs are granted is just a little bit better than before the Great Recession,” Channel said.

Sharga also noted that financial crisis-qualified mortgage rules helped mitigate unnecessary risks that came back to bite consumers during the Great Recession.

In particular, most adjustable rate products are capped at the level of the rates that can be raised during the first adjustment and throughout the duration of the loan. based on Consumer Financial Protection Bureau (CFPB) standards.

According to the CFPB, the first rate change generally cannot exceed 2% of the initial rate, while the cap over the life of the loan is usually around 5% increase.

“It was a very different scenario to what we find ourselves in today when people are putting reasonable down payments on properties in many cases,” Sharga says.

Homeowners’ equity also provides protection for borrowers, as home prices have surged over the past year and a half. According to Sharga, there is $27 trillion of equity in the market today, which is very different from the last economic cycle.

“The conditions we had 10 years ago have nothing to do with the conditions we have today,” he says. “Every time you take out a loan to buy a house, you run a certain risk. The only risk you are considering right now is if rates go up during this period before your first adjustment.

Still risky

Despite safeguards designed to prevent borrowers from being overwhelmed by rate change, the nature of a variable rate mortgage is still inherently riskier than a fixed rate product.

At the moment, an ARM-powered meltdown is unlikely, but Channel says that over the next few years that could change if it turns into another issue, like it did in the early 2000s.

“A lot of people who are getting ARMs right now probably won’t see their rates change in the next five years, so there’s several years of wiggle room, and certainly no one knows where the rates will be six months from now, yet. less in five years,” says Channel.

“It’s worth pointing out that what led to the housing meltdown last time around was good intentions that turned into something unsustainable,” Channel said. “There’s been this real push to make home ownership more accessible and for lenders to be able to give more loans to more people, and that has helped some people.”

According to Channel, if house prices stay high and rates stay high or climb higher over the next decade, government agencies and lenders could be similarly pressured to become more permissive with borrowers.

“You can very quickly find yourself on a slippery slope towards what got us in trouble last time, and I think it’s possible that ARM is part of that problem again,” he adds.

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