Chris Whalen, CPA Tax Memo - Be Aware - New Mortgage Products Mirror Old Unsafe Mortgages You must protect yourself and your family by reviewing realistic scenarios for the long term financial ramifications of any new mortgage loan you are considering. This Tax Memo has important information for all taxpayers. Please share this with your networks and contacts. Please contact me with any questions and to schedule a consultation. Chris Whalen, CPA (732) 673-0510 chriswhalencpa@gmail Rules enacted after the housing crash to protect consumers from irresponsible lending practices may do little to prevent borrowers from taking on too much debt, recent trends suggest. Home buyers are again signing up in droves for risky adjustable-rate mortgages — the same loans that contributed to countless foreclosures just a few years ago. Adjustable-rate mortgages, which offer low teaser rates which can rise substantially over time, accounted for 14% of all mortgage applications in August (in dollars), up from 10% a year ago, according to the Mortgage Bankers Association. For borrowers, the appeal of an ARM is twofold: cheaper rates, and, as a result, larger loan sizes than people would qualify for with a fixed-rate mortgage. Mortgage experts, however, warn that ARM borrowers are being approved at interest rates that are far lower than what they could end up paying, and the new rules that were supposed to protect consumers from such situations are failing. “It is back to caveat emptor — the buyer has to look out for him or herself,” says Brad Hunter, chief economist at Metrostudy, a housing market research and consulting firm. Prior to the downturn, lenders could approve ARM applicants based just on the loan’s introductory rate, and when rates reset, many borrowers were unable to keep up with their monthly payments and went into foreclosure. Since then, mortgage applicants have been expected to pass tougher hurdles to qualify for a loan, including making larger down payments and having higher credit scores. And earlier this year, the Consumer Financial Protection Bureau, which was established by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, said lenders will need to make sure borrowers can afford monthly payments by using the “fully-indexed rate” — which is defined as the margin the lender charges on this loan plus the index it’s pegged to — or the introductory rate, whichever is higher. (This won’t officially go into effect until 2014, but many lenders say they’re already following the rule.) Here’s the problem. With indexes near historical lows, the fully-indexed rate on some ARMs is actually lower than the initial teaser rate. Consider the 5/1 ARM, the most popular ARM, which has a fixed rate for the first five years before becoming variable. Its fully-indexed rate is often pegged to the one-year Libor, which is down to 0.67%, and a margin of 2.25 percentage points, which results in a 2.92% rate. That’s lower than the current average introductory rate on 5/1 ARMs of 3.5%, according to mortgage-info website HSH. (In fact, the introductory rates on average have been higher since the end of June, according to HSH.) Even worse, both rates are nowhere near the highest rate ARM borrowers could incur. During the sixth year of a 5/1 ARM, the rate they pay can increase by up to five percentage points. So borrowers who are signing up for a 5/1 ARM now with an initial rate of 3.5% could pay up as much as 8.5% in 2018. The CFPB added a rule requiring lenders to consider highest possible rate within the first five years, but since most ARMs have a five-year teaser rate, that will have no effect on loan approvals. The bureau says this was still beyond the provision included in Dodd-Frank. While there’s no way to know whether rates will shoot up so much, mortgage experts say it’s likely that rates will continue to climb. “It’s a reasonable bet that rates are going to be higher — the question is how much,” says Keith Gumbinger, vice president at HSH. A CFPB spokesman says the bureau last year proposed that lenders inform ARM borrowers about the highest rate and monthly payment that they could wind up with, though it’s unknown whether that rule will be enacted. Lenders say borrowers have been especially tempted by ARMs over the past few months because their introductory rates haven’t been rising as fast as the 30-year fixed mortgages. As rates rise, home buyer demand for loans is dropping while many applicants who are still pursuing mortgages are finding ARMs more appealing. The spread between a 5/1 ARM and a 30-year fixed mortgage has been over a full percentage point on average every week since May 10, according to data from HSH. To be sure, borrower interest in ARMs remains far from the peak, which occurred in late March 2005 when they accounted for 52% of mortgage applications in dollar amount, according to the MBA. But experts say ARMs share will likely continue to rise as fixed-rate mortgages become more expensive. Before signing up for an ARM, borrowers should consider how long they’ll need it. Rising rates may not impact borrowers who sell their home or pay off the loan before its fixed-rate period ends. Those who may stay put in the home they’re buying for a longer time should consider whether they’re better off taking the savings from the temporarily lower monthly payments ARMs offer or signing on for a fixed-rate mortgage that could end up being more affordable in the long run. Please contact me with any questions and to schedule a consultation. Chris Whalen, CPA (732) 673-0510 chriswhalencpa@gmail
Posted on: Tue, 10 Sep 2013 20:25:37 +0000
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