Jung Lim plans to offset the cost of rising mortgage rates by using an adjustable-rate loan to buy a home for his expanding family. For the California endodontist, the money he’ll save makes up for the ARM’s risky reputation.
Lim, 38, whose wife is expecting a second child in December, is leaving a two-bedroom condo in Los Angeles’s Hancock Park to buy a four-bedroom house in the city’s Sherman Oaks neighborhood for $1.12 million. His lender offered him a rate for an adjustable mortgage that is about a percentage point cheaper than a fixed loan.
“If I could have gotten a 30-year fixed at the interest rate I’m getting the ARM for, I would have felt a lot more comfortable,” said Lim, who’s also a professor of endodontics at the University of California, Los Angeles. “But I’m hoping to refinance in five years or less. And we’ll be in the house for about 10 years so we could also sell. Hopefully prices have bottomed so we won’t be underwater then.”
In the second year of the U.S. housing recovery, the loans that helped trigger the housing bust are making a comeback. Applications in late June rose to the highest level since 2008 after the Federal Reserve sent fixed rates surging by signaling it may curtail bond buying credited with pushing borrowing costs to the cheapest on record. The average 30-year fixed-rate mortgage jumped 1.2 percentage points in mid-July from May to the highest level in two years, adding about $200 a month to payments on a $300,000 mortgage.
Sticker Shock
“We’ve seen a shift in the way people look at adjustable- rate mortgages,” said Cameron Findlay, chief economist of Discover Financial Service’s home-loan unit. “They’re still skeptical about using ARMs, given the role they played in the financial crisis, but the sticker shock of what fixed rates have done is making them look for alternatives.”
ARMs, loans with interest rates that adjust after initial fixed periods, usually of five, seven or 10 years, helped fuel the housing bubble and contributed to soaring defaults in 2008 that sent the economy into a tailspin.
In addition to loose underwriting standards that extended mortgages to people who couldn’t pay, variations included loans that had interest-only periods or initial teaser rates that became known as exploding ARMs when the rate spiked. Lending was based on the presumption that house prices would keep rising and the debt could be refinanced before onerous terms kicked in.
Unqualified Buyers
“When you give unqualified buyers a rate they won’t be able to afford based solely on the presumption that home prices will always go up, it’s not going to end well,” said Keith Gumbinger, vice president of HSH.com, a Riverdale, New Jersey- based mortgage website.