It used to be that adjustable rate mortgages (ARMs) were a big part of the mortgage marketplace, but in recent years their use has tumbled to the point where sightings are rare.
The VA says that in fiscal 2012 it guaranteed 539,884 loans. Of that number just 555 were adjustable-rate mortgages. That's about one-tenth of 1 percent.
The use of ARMs became widespread with the passage of the Alternative Mortgage Transaction Parity Act of 1982. This was a law which said that banks could make not only adjustable-rate mortgages but also interest-only loans and mortgages with balloon payments.
The need for the law arose from the fact that savings-and-loan associations were able to originate ARMs but under some state rules banks could not. Effectively, the federal legislation preempted state laws and gave banks the authority they needed to compete for ARM borrowers.
The fact that the 1982 law passed at all was something of a miracle. Previously there had been efforts on Capitol Hill to ban what were called "variable-rate" mortgages. One can argue that such bans might actually have passed until the idea of a mortgage with a variable rate was fundamentally changed with the addition of annual and lifetime caps for mortgage rates as well as annual payment caps. Such caps greatly reduced the risk associated with variable rates and thus came into being the modern ARM as we know it.
The program of VA loans is notable because it has an annual rate cap of 1 percent and a 5-percent lifetime cap for ARMs and 3/1 hybrid ARMs (HARMs), loans where the initial rate is fixed for the first three years of the loan term. For a 5/1 hybrid, there are 2 percent annual caps and 6 percent lifetime caps.
ARMs generally make the most sense during periods when interest rates are high because the start rates for such loans are typically lower than the rates borrowers would otherwise pay for fixed-rate financing. However, when interest levels are near record lows such as they are now most borrowers want to lock in today's fixed rates as a hedge against inflation and the possibility of higher home mortgage costs.
The fact that so few ARMs are being originated today is good for both borrowers and lenders in the sense that less risk in the mortgage marketplace helps everyone. While fixed-rate mortgages also have risk – the possibility that financing will be available at lower rates – at least such borrowers know that monthly costs for principal and interest will not increase. In an economy which is less certain than in the past, payment stability is a big deal.
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