PART ONE: “In Defense of ARMs”by Tim Manni
Below is part one of our five-part article “In Defense of ARMs” (written by HSH VP Keith Gumbinger). Each day this week we will publish a new section, so be sure to check back in.
They’re Neither ‘Evil’ Nor ‘Toxic’
As the mortgage and housing crisis wends its way toward an inevitable solution, we’ve been told all too often that Adjustable Rate Mortgages (ARMs) are either the cause of — or at the heart of — the market’s failings, putting borrowers and lenders alike out on the street.
These claims have rattled their way across the political landscape, as well, with the proposed Consumer Finance Protection Agency looking to establish rules for “plain vanilla” products. It’s a safe bet that ARMs — vilified as they have become — won’t be counted among the approved products.
However, arguments that ARMs are “evil” or “toxic” simply aren’t supported by the facts. While it’s true that most subprime products were ARMs and have a spectacular record of failure, and that even some ‘prime’ ARMs have failed as well, it’s also true that many ARMs haven’t failed, and may have even provided tremendous value to their holders.
It’s also a fact that ARMs, in varying forms, have been a part of the residential mortgage marketplace for more than a quarter century. A product with a 25-year history can’t be all bad, or it would have disappeared from the market. Some ‘flavors’ of ARMs today are, in fact, fading from view as consumers have moved away from them — even old standbys like the traditional one-year ARM. Like every financial instrument, they’re not meant for everyone, nor are they always useful.
It’s important to note that ARMs were born of a need brought on by high interest rates. They were based on the premise that borrower and lender alike should share the risks in an ever-changing marketplace. In exchange for accepting such risks, the borrower benefits from a somewhat lower starting rate plus a chance at a lower interest rate in the future — perhaps even declines which might persist for years. This is an important qualifier that you’ll want to remember for later in this discussion.
The Product, or the Borrower?
While the forensics into the failure of certain ARMs will go on for years, it’s worth noting that there is a distinction which needs to be made between the product itself and how it is utilized.
Suppose one needs to buy a vehicle. There are lots of choices, and all will get you from point A to point B. What type should one get? A buyer must decide what kind of vehicle best suits his or her needs, whether it is a sports car or a dump truck. It goes without saying that the two are meant for different purposes and aren’t interchangeable, and a buyer selecting the wrong one will find an ill fit for their needs. This is also the case with financial products, including mortgages, which were developed to address certain time frames, needs and goals.
The oversimplified point is that some, if not many, of the problems with ARMs were not caused by the product, but by how it was applied relative to the user’s needs or wants.
It’s also worth saying that the sellers (salespeople) at that car lot are interested in selling you something and will try to present you with as many choices as they can in order to make the sale. They can’t make a living if they don’t make sales, and for the most part, their role isn’t to help you decide what kind of vehicle is right for you. This may change in the future.
That said, we agree that, if an ARM borrower failed due to circumstances beyond his control — malfeasance, steering, predatory lending practices, and such — then let’s expose and, if warranted, prosecute those bad mortgage actors to the fullest extent of the law. But to overly restrict or even ban access to a product which has proven to be helpful and useful to many hundreds of thousands – perhaps millions – of borrowers is just plain nuts. Why penalize all borrowers, now and forever, for the failings of some of yesterday’s? It just doesn’t make sense.