Can I Lose My Long Beach Home Because Of a 7-Year ARM?

In today’s Long Beach Mortgage Rates Report, I highlighted a 7-year ARM.  The post drew this comment:

You suggest a 7 year ARM? What happens if home values don’t fully recover in 7 years? I dont want to be stuck owing more than what my home is worth when my rate resets.

Great question.  It shows how The Media is disseminating poor information about this mortgage crisis.  A 7-year ARM is a fully-amortized loan (which means it will be paid off in 30 years) with a fixed rate and fixed payment period for the first 84 months.  For a loan funded in March, 2008, that means the first payment will be in May, 2008 and will not change until April, 2015; let that sink in….2015.

At the end of 7 years, the loan turns into a one year ARM, amortized for 23 more years.  The new interest rate is determined by adding the index and the margin together.  Most ARMs are based on the LIBOR index, which today is about 3.5%.  Most ARMs have a margin of 2.75.  That means that if this loan were to adjust today, the new rate would be about 5.75%…not so bad, huh?  As you can see, rate rests aren’t that awfully bad.  In fact rate resets are accounting for less than 2% of the foreclosures in California.

The following Question and Answers are not part of the original comment but frequent questions I hear daily.  My answers may appear to be flippant; they’re not intended to be. 

WARNING:  HARD-CORE TALK ABOUT THE REAL ESTATE DECLINE AND MORTGAGE CRISIS

Why is everyone getting foreclosed upon, in California, then Brian? 

Simple.  They never could afford the loan in the first place.  Borrowers (and unscrupulous mortgage originators) “gamed the system” and overstated their income ( they lied about it) to get a loan approval.  When the loan reset, they couldn’t refinance their existing loan (because the “liar” loans aren’t available anymore). 

The loan balance, for this loan, will never go up because the borrower is required to pay both principal and interest each month.  The loan balance will actually be much lower in 7 years.  For a $400,000 loan, the balance will be paid down to about $355,000 by year 2015.  The loan can then be refinanced or kept.

What if values don’t go up?

The loan can still be refinanced unless values drop even further and continue to drop, over a seven year period.  Values would have to decline some 10% more, and stay down for 7 years for this loan to not qualify for a refinance.  If you think that might happen, don’t buy a home in Long Beach.  Long Beach real estate prices have dropped quite a bit, since last year.  It would be highly unlikely that they drop even more, and refuse to rise in the next 7 years.

Can you guarantee that I’ll be able to refinance or that values won’t drop, In Long Beach, over a 7 year period?

Of course not.  All I can point out is that Southern California real estate is still in demand over the long-term.  Some 12 million more people are expected to move to California between 2000 and 2020; that’s some 50,000 people each month.

…but you can’t GUARANTEE this, can you, Brian?  That’s why I should take a 30-year fixed rate loan, right?

I can’t guarantee that the sun will set on the Pacific Ocean tomorrow.  Nothing in life is guaranteed.  The difference between a 7-year ARM and a 30-year fixed rate loan is a full 1%; for a $400,000 loan, that some $325/month in savings.  Invest that $325 difference into a conservative mutual fund and watch it grow to $40,000 over the next 7 years.

If Long Beach real estate continues to drop, over the next 7 years, you will have made a bad investment by buying a home in Long Beach.  The economy will be in a full-blown depression.  That extra $40,000 will come in handy for your relocation.  (not meant to be a smart-alec comment; it’s the truth)

Loans are personal.  That’s why we suggest you use a mortgage planner, like me.  We’ll match up your risk tolerance, financial goals, and liquidity with the right loan.  Is a 7-year ARM better than a 30-year fixed rate mortgage?  Not always but with a 1% discount on the rate, it sure gives us lots of room to be wrong.  I can be contacted by telephone at (858)-777-9751

Posted on March 3, 2008 by Laurie Manny