Real Estate

How this 'villain' of the housing crash could be right for you now

Creative mortgages return
Creative mortgages return

Mortgage rates have been heading higher since the presidential election, and they are already pricing some buyers out of the housing market.

There is a way to get some of those buyers back in, if they are willing to take a little risk.

The average rate on the popular 30-year fixed is at its highest in two years, but other mortgage options offer lower rates, namely, adjustable rate mortgages. These so-called ARMs still carry the stigma of being the villains of the housing crash. Lenders offered all kinds of "creative" ARMs then, some with no down payments, crazy-low teaser rates, interest-only payments and loans that actually got bigger as time went on (negative amortization).

Most of these products are now illegal under new mortgage regulations, but ARMs are still around, and they can be the right product for a lot of borrowers. They can, in fact, be very low risk.

"These aren't the ARMs of the past," said Mat Ishbia, president and CEO of United Wholesale Mortgage. "It's not any more difficult for a borrower to qualify for an ARM than a fixed rate mortgage, as long as the term of the ARM is over five years."

Ron Antonelli | Bloomberg | Getty Images

ARMs now require principal as well as interest payments, and the rate can be fixed for up to 10 years, so there will be no change in the interest rate during that time.

"Statistics show that over 90 percent of homeowners don't stay in the same mortgage for nine years, for a variety of reasons, so more people should be looking at ARMs as a viable option for themselves and their families," said Ishbia.

Borrowers today still shy away from ARMs. They now make up just about 6 percent of total mortgage applications, according to the Mortgage Bankers Association. During the housing boom, in 2006, they made up about 35 percent, according to Black Knight Financial Services

Last week, the average rate on the 30-year fixed mortgage was 4.28 percent, a full point higher than the average a five-year ARM. It's likely that borrowers are still choosing the 30-year fixed because rates are relatively low, even though they're rising, but that could change.

"I think you're going to see more programs focusing on ARMs. I think you'll see more flexibility in the terms," said Joe Tyrrell, executive vice president of corporate strategy at Ellie Mae, a software company that processes nearly one-quarter of all U.S. mortgage applications.

Qualifying for an ARM today is far different than it was during the housing boom, when really anyone could get just about any loan. The underwriting is actually similar to that of a 30-year fixed loan. Lenders are required to look not only at whether the borrower can pay the fixed rate over the entire term of the loan, but also how much that rate could increase after the fixed period, and if the borrower can afford that. There can be no "payment shock" at the end of the fixed period. The borrower must be shown exactly what all payments will be.

So is it harder to qualify for an ARM?

"In general, the answer is no," said Bryan Sullivan, chief financial officer of loanDepot. "Mortgage qualification is determined by a homebuyer's credit score, the loan-to-value (LTV) ratio of the home loan and the customer's debt-to-income (DTI). ARMs are typically lower priced and also have a correspondingly lower LTV ratio which may make it more difficult for potential homebuyers to qualify."

How do you know if an ARM is right for you? It really comes down to each individual borrower. Generally, an ARM will allow a homebuyer to buy a more expensive home, since it offers a lower interest rate. It might work well for someone who expects to earn a higher salary in the future, when the rate adjusts higher (rates can also adjust lower, but that is unlikely in this rising rate environment). Homeowners can also refinance when the fixed term of the ARM is over, although rates could be higher at that time as well.

ARMs may be best for younger borrowers, who tend to be more mobile. First-time homebuyers, who intend to trade up quickly, can save a lot of cash using an ARM.

"If interest rates continue to rise, but really as home prices continue to appreciate, I think that you will see more people looking at ARMs when they're looking to purchase more home," said Tyrrell.