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Jack M. Guttentag The Mortgage Professor

Jack M. Guttentag, The Mortgage Professor

ARM Borrowers: Don't Keep Your Heads in the Sand

by Jack M. Guttentag

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Posted on Tuesday, September 4, 2007, 12:00AM

In recent weeks, my mailbox has overflowed with messages of distress from borrowers faced with an imminent rate adjustment on their adjustable-rate mortgages (ARMs). Most of them want to refinance, but many of those who had earlier taken 100 percent loans are stuck. With the current softness in the housing market, they now owe more than their homes are worth. Lenders are strongly resistant to refinancing loans with balances exceeding property values.

A striking feature of the letters I receive is that the great majority of the borrowers don't have a clue as to exactly what is going to happen to their ARM rate. They know it is going to go up but have no idea how much. Many of them assume that it is worse than it actually is, perhaps because this gives them an excuse for not doing anything to prepare.

If this describes you, it is time to shake the sand out of your eyes. While you can't know exactly what your ARM rate will be on the adjustment date -- that depends in part on what happens to market rates between now and then -- you can know what your ARM rate would be if the adjustment occurred today. Call this the current projected rate, or CPR. As the adjustment date gets closer, the CPR becomes an increasingly good estimate of the actual rate on the adjustment date. You use the CPR to plan your next move.

Calculating Your Current Projected Rate

To calculate the CPR, you need four pieces of information from your note. Piece one is the interest rate index to which your ARM rate is tied. Indexes have names like COFI, Libor, CMT, MTA, CODI, and Prime Rate. When you have identified the one used by your ARM, go to www.mortgage-x.com and find its most recent value. When I checked on July 31, most of the indexes were in the range of 4.3 percent to 5.4 percent.

Piece two is the margin, which is the amount added to the index to determine your rate. This is the critically important number because it varies so widely, from 0.75 percent to 7 percent or more. Because it is not a required disclosure, most ARM borrowers don't know what it is until they are hit with a rate adjustment.

The other two pieces of information you need from the note are the adjustment cap, which limits the size of a rate change, and the lifetime maximum rate. Not all ARMs have adjustment caps, but they all have maximum rates.

The Rate-Adjustment Rule

The rate-adjustment rule is that the new rate will equal the most recent value of the index plus the margin, subject to the caps. Here are some examples:

1. Current rate 5 percent, current index 5 percent, margin 2.75 percent, adjustment cap 3 percent, maximum 10 percent. The new rate is the index plus margin of 7.75 percent; the caps are not a constraint.

2. Current rate 4 percent, current index 5 percent, margin 2.75 percent, adjustment cap 3 percent, maximum 10 percent. The new rate is the current 4 percent rate plus the 3 percent rate-adjustment cap, or 7 percent, which is below the index plus margin.

3. Current rate 5 percent, current index 5 percent, margin 6 percent, no adjustment cap, maximum rate 10 percent. The new rate is the maximum of 10 percent, which is below index plus margin.

Where the rate is constrained by the rate-adjustment cap, as in example 2 above, the respite is only temporary. If the index value stays the same, the rate will increase to index plus margin at the next adjustment.

Articles such as this one would not have to be written if the lenders servicing ARMs reported the CPR every month, along with the payment associated with it. They calculate it now, but only for the month preceding a rate adjustment. It would be quite simple to do it every month so that borrowers always knew where they stood and had time to prepare for what they saw coming.

I have not done a survey but would be surprised if there are any lenders who do this. It is symptomatic of the wretched level of service provided by mortgage-servicing agents, a subject on which I have railed on numerous occasions.

NOTE: If you service ARMs and do provide the CPR monthly, send me a copy of your monthly statement and I will happily eat my words in public.

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25 Comments

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  • Yahoo! Finance User - Friday, September 7, 2007, 7:50PM ET  Report Abuse

    • Overall: 1/5

    Poor article. Here is another try to paint those greedy borrowers as innocent. There are a lot of mortgage calculation tools on the internet that are more useful than this article. It’s not fair to spend tax money to save those wanting to be rich without doing any homework

  • mark - Friday, September 7, 2007, 7:38PM ET  Report Abuse

    • Overall: 1/5

    Mr. Guttentag is very misinformed about how ARM's work. And, as one of the other comments pointed out, all borrowers were given a Truth in Lending Document, at least twice, calculating the payments over the life of the loan. Yes, some mortgage lenders took advantage of people, but these borrowers were too greedy or shortsighted to see that they were taking a big risk with that ARM, and they need to take responsibility too. If you try to calculate your ARM based on this article, you won't even be close.

  • Yahoo! Finance User - Friday, September 7, 2007, 7:30PM ET  Report Abuse

    • Overall: 3/5

    Red: You are doing a disservice to your customers by pushing the interest free ARM. What planet have you been on these last few weeks? The high Loan to Values combined with interest free payments and negative amortization, not to mention falling values has put many homeowners in a position where they will be "mailing in the keys" This will further damage the real estate market due to a flood of homes in foreclosure that will be hitting the market. As a mortgage wholesaler I NEVER pushed the Option ARM or any product with negative amortization. And I blame irresponsible loan officers like you for our current situation. I gladly let loans go to other lenders - and lose my commission rather than put a person in a situation that is sure to cause them problems down the road. My question for the author of this story is why the negative amortization and interest only aspects (which have been a large percentage of loans written in the past few years) were totally omitted. This story is rather dated - a by a few years - the ARMs he is describing are the "old fashioned" products, not the loans that are wreaking havoc on our country right now.

  • Yahoo! Finance User - Friday, September 7, 2007, 7:28PM ET  Report Abuse

    • Overall: 1/5

    Mr. Guttentag knows exactly what he is saying. Now, the fact that he and other experts have a mightier than thou attitude toward the Loan Originators (LO), well that’s an entirely different story. I have been in the mortgage industry for seven years, I explain to my borrowers the differences between ARM and Fixed. Fact, Fixed is not always best. If due to frequent job relocation or for what ever reason, you don’t see yourself living in the same place for more then 5 years then getting a Fixed Mortgage is just plan dumb. Now if you don’t know where you will be in 5 years, then I would play it safe and get a Fixed Mortgage. The fact is that 8 out of 10 people want to have the lowest payment period. Of course, I explain the differences, and they still insist on the lowest payment. By law here in WA State, we show them the TIL (Truth in Lending) a minimum two times. The Lender also sends the borrower a TIL, the TIL shows what the payment will be in a worst-case scenario based on the CAPS and MARGINS. The customers see this and cannot claim that they were suckered. It was their quest to have a bigger, better home then their friends, and of course, the right to brag at a BBQ on how low their payment is. That is why they are in the situation they are in now. Not because they were never given an option of getting a fixed mortage. The LO has become the scapegoat for the current mortgage crisis. When the truth is that the lenders carelessness is what started the crisis. Most people with common sense would be amazed at some of the stuff that they approved and funded. Then New Century flat out lied about their earnings last year, once the truth came out that the #3 Sub-Prime Lender was cooking the books, well, Wall Street overreacted and stocks began to plummet. Last, lets not forget the media, with their Chicken Little style of reporting, scaring off what few investors remained in the market.

  • james p - Friday, September 7, 2007, 7:22PM ET  Report Abuse

    • Overall: 1/5

    Catchy title, useless article.

  • Gold Crown Mortgage - Friday, September 7, 2007, 7:17PM ET  Report Abuse

    • Overall: 3/5

    As a mortgage broker, I find it very disturbing that so many people know so little about their ARMs. Lenders have an ethical responsibility to explain their product in a way that consumers understand (I'm not sure I agree a monthly "CPR" is the answer though). That said, customers share the responsibility for understanding what they are purchasing. A loan is a product, just like a house. When you purchase a home, you are also purchasing a loan. Don't ever leave a lenders office until you understand that loan. If he can't explain it, find someone who can and take your business there.

  • Travis - Friday, September 7, 2007, 7:16PM ET  Report Abuse

    • Overall: 3/5

    I think it is kind of sad that people can't read anymore. There is a reason that it takes 3 days to fund a mortgage. You're supposed to read the documents that your lender gave you and if something doesn't make sense contact them and ask what it means. I want to know who buys something for $50,000 or $500,000 without reading the details of what it's going to take to pay this back. If you can't afford it you shouldn't of bought it...but that's unamerican, how big can I go and how little can I pay for it. If you like where you live now you'll find a way to pay for it. If you don't, sell, take the loss and think harder about your decision next time.

  • MarkO - Friday, September 7, 2007, 7:06PM ET  Report Abuse

    • Overall: 1/5

    I tried to find the CPR projection for my soon to adjust refinance per the article referring to mortgage-x.com. I could not find anywhere on the site how to get the current projected rate for my loan. Anyone know how? The site search feature was no help and the site does not allow any questions

  • Abdullah - Friday, September 7, 2007, 7:03PM ET  Report Abuse

    • Overall: 3/5

    Not bad for a general information, at least we have to give him the credit fot explaning ARM

  • Size - Friday, September 7, 2007, 6:58PM ET  Report Abuse

    • Overall: 4/5

    Like at least one in here, I too was told one thing at closing and then found out later that it was another, all together crappy ARM that I wasn't aware I was signing. This was with a mortgage broker. Countrywide bought the loan and from about the time it was matured one year, I had non-stop calls to try to get out of that ARM. Someone said that Countrywide Full Spectrum Lending screwed them, I had an altogether different and more pleasant experience with them. Countrywide helped me Re-Fi and get into a 30 year fixed which exceeded my expectations. My credit was bad several years ago when I built the house due to working for a company that went bankrupt due to the Enron scandal, I then lost my home to foreclosure in Michigan and moved back to Ohio. It was hard to find someone to take a chance giving me a mortgage loan until I put down $83,367 down on my house. This was 35% of it's value. I refinanced the year after to lower payments because in that year, due to all the foreclosure crap, my Credit went to hell, with a score of 547. The following year at Re-Fi it was 632. The broker gave me a good deal, but hurried me through all the hidden things in which I learned of about three weeks afterwards when I read the documents. (I KNow I should have read them right a way, I took the guys word, something I no longer do) Countrywide worked with me, seeing that my credit was still on the rise this spring at 719, they got me into a fixed rate that I do not plan on re-fi'ing anytime soon. I hated the mortgage industry after that broker screwed me, by Countrywide gave me the faith again. I guess it is really about who you deal with there. I spoke three people, shopping around, one made promises she couldn't keep, one made promises that he never called me back on, and the final one made promises that not only was the final deal, he was honest from the beginning...

  • Jeremy - Friday, September 7, 2007, 6:55PM ET  Report Abuse

    • Overall: 5/5

    As a mortgage professional this is pretty valuable information. Many of the people who are losing their home, purchased it 2-3 years ago with no money down. They did so under the impression that home prices would continue to increase. Now that the market has turned upside down, many of these borrowers cant refinance because nobody is going to lend on 110% of your home's value. The best bet for many of these people is to short sale. When and if that doesn't work, walking away from the property has been a popular choice. Leave countrywide and the others with the bill if they won't renegotiate some of the terms and buy another house in 2 years after your credit recovers slightly. You might even be able to buy your same house for $100K cheaper than you did 2 years ago.

  • Yahoo! Finance User - Friday, September 7, 2007, 6:47PM ET  Report Abuse

    • Overall: 1/5

    People who won't understand how ARM works will not understand this anyway. He just made simple thing seems more difficult..like those lenders.

  • steve8a - Friday, September 7, 2007, 6:41PM ET  Report Abuse

    • Overall: 4/5

    Is there any recourse for someone who was misled at the time they financed their home purchase? I was told one thing, shown paper work explaining one thing and now find my loan is something different.

  • Yahoo! Finance User - Friday, September 7, 2007, 6:39PM ET  Report Abuse

    • Overall: 5/5

    Why do I have to give a good rating to post a comment? I paid off my home at 8%, 5 years ago, now we give a break to people whom may have made bad decisions? Pay your way It's life deal with it.

  • Dena - Friday, September 7, 2007, 6:39PM ET  Report Abuse

    • Overall: 5/5

    This article provides a wealth of information on ARMs. "Mortgage Servicing Companies" are a joke, albeit a bad one. Organized Crime has more integrity than these predators.

  • Techno Broke - Friday, September 7, 2007, 6:38PM ET  Report Abuse

    • Overall: 5/5

    Countrywide, Countrywide... Hmm. As they bought and now have adjusted my arm which now throws me higher in the loan to value range. Which gives you two options. Wait and hope your score get almost to 800 to get out of spectrum (sub prime) lending or see if you reach the cap and be stuck with a balloon balance to payoff at the end. Capitalism is only great when you are on the other end receiving. And after their late news. What end does that put them on? How will that affect people in ARM's? Whatever happened to the goodness of being a vet and VA loans?

  • Yellowsand1964 - Friday, September 7, 2007, 6:32PM ET  Report Abuse

    • Overall: 5/5

    GREAT information , we have one arm mortgage, and Fidelity sold our account to 3 different banks so we have 3 different account, we almost lose our home, why a least can send a email when they sold the accounts? is as a game for them?

  • nicole r - Friday, September 7, 2007, 6:30PM ET  Report Abuse

    • Overall: 4/5

    a lot of this type of info should be available to people BEFORE they get these ARM loans. Im in the process of getting a refi for my ARM. I have a bit put aside to cover the difference if it takes a few months to get it done since I knew it was coming but these loans are just short of higway robbery! dont understand the point of selling and loaning people money for a house that they may not be able to keep. So basically people are "buying" a house for a couple of years getting kicked out and the house is sold again and again. Why are we worried about what is going on on the other side of the world when this is happening to Americans?

  • J - Friday, September 7, 2007, 6:27PM ET  Report Abuse

    • Overall: 1/5

    Well, first of all, the customer can call their mortgage servicer for the answers above. This is MUCH easier than reading this worthless article, and then doing all of the various calculations, etc. Also, on ALL Truth in Lending statements, which ALL borrowers receive TWO times OR MORE prior to the loan being funded, the above information is calculated at MAX values, so Mr. Guttentag is lying or terribly ignorant to what he is writing about. This is a worthless and misleading article.

  • Reader - Friday, September 7, 2007, 6:17PM ET  Report Abuse

    • Overall: 5/5

    Great information! I was lucky enough to recently re-fi at a fixed rate, but prior to that had no idea when, why or how much my ARM would increase. Understanding it may have alleviated some of the overwhelming stress of living with an ARM. Never again.

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