ARMs of mass destruction?

A senior economist for a leading online lending marketplace has urged both lenders and originators “not to go overboard” with adjustable-rate mortgages (ARMs), saying they should not be used “as a sort of a band aid or crutch” to simply originate more loans.

Jacob Channel (pictured) of Lending Tree said ARMs should only be offered to people who can “absolutely” afford them.

Potentially risky ARMs have gained in popularity in recent months. Data from the Mortgage Bankers Association (MBA) shows that ARMs now account for almost 10% of all mortgage applications in the US, compared to just 3% at the start of the year.

The shift appears to coincide with the rapid rise in interest rates, record-high home prices and – from the perspective of brokers – the fall in refinance volume.

Part of the appeal is that ARMs offer introductory rates that are much lower than for conventional mortgages. According to Bankrate’s latest survey of the largest mortgage lenders in the US, the annual interest rate for a first, five-year (5/1) average ARM is 4.84%, while the average 10/1 ARM APR is 4.47%, which is considerably lower than the 5.29% average for a current 30-year fixed rate loan product.

Read more: New LendingTree index tracks spreads in mortgage lender APRs

The downside for borrowers is that they run the risk of defaulting on their mortgage if rates shoot up after the five- or 10-year period expires.

Speaking to Mortgage Professional America (MPA), Channel urged lenders and brokers to show caution when originating ARMs.

He said: “We should make sure that lenders don't go overboard and that adjustable-rate mortgages, if they are going to be originated, are only originated to people who absolutely can afford them, and they aren’t used as a sort of a band aid or crutch to just start originating more loans.

“It’s something that we have to keep a very close eye on, because it's gotten us into a lot of trouble in the past, and we obviously don't want a repeat of 2008.”

Channel’s pointed remark was in reference to the role ARMs played in the great economic crash 14 years ago, which sparked the collapse of the housing market and left millions of people with mortgages they could no longer pay, mostly because they were given ARMs they could barely afford even with initial low rates.

Channel stressed that there were “plenty of examples” of borrowers today being able to pay off ARMs and not defaulting, adding that lenders were also “a lot more diligent” and stringent than before the collapse of 2008, but he warned that “just by their very nature, because there's more unpredictability baked into them”, they were riskier than a fixed-rate mortgage.

Nonetheless, the trend in ARMs looks set to continue, reflected by the fact that big lenders such as UWM and Homepoint have been launching new adjustable-rate mortgage products over the last six months.

Last November, UWM announced a prime jumbo loan program offering competitive pricing on five-, seven- and 10-year ARMs, with the Pontiac-based wholesale lender stating that the new loan products were intended to give brokers “a competitive advantage”.

Homepoint, the third largest wholesale mortgage lender in the US, followed suit this week, announcing the launch of a new jumbo ARM in response to the high-rate environment.

According to Channel, Lending Tree’s data was also beginning to reflect the shift to ARMs in the market.    

Read more: Homepoint introduces new jumbo ARM product

“At the start of this month we looked at Lending tree users who were offered an adjustable-rate mortgage and I believe that nationwide twice as many were offered the start of this year versus the same period in 2021.

“At the moment, ARMs don't make up a huge portion of mortgages that are being originated, but I do think that the potential is there for them to start growing to the point where they do become a real concern,” he added.

Non-QM products have also become increasingly popular over the last year and a half, having generated $25 billion in loans in 2021 alone, but Channel dismissed suggestions that they were as potentially risky as ARMs, because they had “pretty strict income and credit requirements”.

He said: “There’s still a lot of double checking and due diligence going on to ensure that people who get these kinds of loans can afford them and aren't likely to default on them.”