by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
I don’t look real smart today, do I ?
Mortgage rates in general took a fairly substantial dive during the previous week with longer term rates dropping double digits in most cases and some rates returning to mid-2006 levels. However, the Mortgage Bankers Association reported a spectacular increase in the interest rate of the one-year adjustable rate mortgage (ARM).
Hold on just one second ! Now is the time when you SHOULD be a contrarian. The alternative title of this post is the one you should read. Wall Street has always been ahead of the little guys and gals. They look into the future, and try to get money committed to best profit off of their forecast. If an annual ARM rate is rising above the fixed rate mortgage rate, Wall Street is trying to induce borrowers to lock up money.
Why would anybody in their right mind do that?
Wall Street thinks rates are going to drop like a ball off of a table. They think the inverted yield curve we’ve seen is a precursor to a recession. The inverted yield curve has indicated an impending recession some 85% of the time since the Civil War – which side would you bet on if this were Vegas?
Nobody likes the R word. I’ve been sensitive to the R word since Bill Gross of PIMCO talked about the housing recession in late 2005. He, and I, are more sensitive to the concept of a “housing recession”; we’re both in California. It’s estimated that close to 10% of the jobs in California are related to the housing industries be they Realtors in Rialto or a painters in Petaluma.
Why the Wall Street shuffle with higher ARM rates? They want you to take the risk of a fixed rate so they can stick them in the MBS pools for a few years. They know those loans will sell at a premium in 12-18 months- when rates are dramatically lower. To continue the Vegas analogy…don’t bet against the house because the house doesn’t lose.
It’s no secret that I’ve talked about the advantages of an annual ARM. Each shoe that has dropped, in 2007, makes the case for annual ARMs more compelling. If you’re buying a home with an annual ARM for affordability, don’t listen to my advice; buy a smaller home. If, however, you are looking to materially lower your borrowing costs for the next few years, an annual ARM may be the solution for you.
Pat Kitano says:
Right on the money Brian…
mortgage
rates are dropping after September 18 if not sooner (they’re gradually dropping now) and the lenders are just
padding their portfolios with fixed rate loans to counterbalance the foreclosed loans looming ahead.
September 4, 2007 — 8:08 pm
Jeff Brown says:
I’m high on my own overflowing endorphins. 🙂 I’m learning from you guys I’m not the Lone Ranger when it comes to the ARM’s being a coming good deal.
Get ready for the onslaught of those who will never learn. 🙂
Thanks guys – you’ve made my very long day.
September 4, 2007 — 8:22 pm
Brian Brady says:
Pat Kitano knows that games they play at Broad and Wall:
http://mariah.com/blogfiesta/2007/08/24/blogger-spotlight-pat-kitano/
September 4, 2007 — 8:23 pm
William J Archambault Jr says:
Brian,
Great post. If you’re right and I suspect you are we’re in for a great and fast ride.
Personally, I think that “The Inverted Yield Curve” is more descriptive than indicative.
There is another possibility. With one exception every time a Democrat has been elected in the last century rates have gone down for 6 months or so then gone high for the rest of their term/s. When a Republican has been elected rates have gone up for 6 months or so then gone down and remained low for the rest of their term/s. The exception G W Bush, but he’s the only Republican elected to his first term with a Republican Congress.
I wasn’t able to locate a chart of the years that “The Inverted Yield Curve” indicated recession, but from what I can remember I think they correspond with Presidential election years.
That this problem has surfaced so early is reflective of the nastiest, dirtiest, vial politics in our history!
I don’t believe that “The Inverted Yield Curve” is the cause because from a Macro point of view there is an equally solid argument that an inverted curve makes as much sense as a “normal” curve.
Regarding holding portfolios waiting for a higher value, well that’s what’s killed most of the lenders that went under.
Lastly “the case for annual ARMs more compelling“ is very simple, historically the ARM is a better deal, but no one ever remembers the money they saved when the rate goes up!
One mans opinion.
Bill
William J Archambault Jr
The Real Estate Investment Institute
First national Mortgage Sources
September 4, 2007 — 11:04 pm
Pat Kitano says:
Oh, the
yield
curve is not inverted any
more, it looks…
kind of normal… last month’s credit crisis sparked a run on safe haven
short term treasuries. That means lenders are in essence bumping that short term
ARM rate artificially high, using the excuse that recent volatility allows them
to price in some sort of “ARM premium”. LOL, lenders know rates are going to
drop, their fixed rate and their ARM products are now overpriced because product
competition has been disappearing as
lenders
fold like dominoes.
They are taking advantage of this window.
September 4, 2007 — 11:53 pm
RE Investor says:
I could not agree more. I have several properties on MTA loans, and I remember people telling me to get in to fixed mortgages. I can say that my payments on my variables are still cheaper, by a long shot than any of the people that told me to get a fixed rate mortgage. Why? Because I was smart on the margin rate. Like everything else, the devil is in the details. The media makes it sound like it is adjustable rate mortgages that are the problem, when in reality the adjustable market is not too bad. The REAL problem is with loans that carried a huge margin above 2.5% to the index. The subprimes were tracking at a low margin until two years in, when they then jack up the MARGIN to 6% ABOVE the index. That is just a bad loan. A good adjustable with a low margin that never adjusts, will keep you happy for a ling time – especially in a recession….
Just my two cents.
September 5, 2007 — 5:16 pm
john says:
Great little post…very inciteful and interesting (we all love the contrarian banter). However, when it comes to adjustable rate mtgs…the fed funds rate is a useless barometer and does not impact mortgage rates….its the libor that affects the arms and libor has its own inverse relationship with fed funds rate. And the truth is the libor is exploding upward taking payments through the roof. I agree fed funds is dropping dramatically in the short term. I also believe america is going to mirror the moves in japan over the last 15 years, however it will be a sharper drop and quicker recovery. meaning real estate drops at minimum 35% nationally, the dollar is down another 30% and interest rates hit just north of 0%. There is no way to avoid this implosion in the housing market or a recession in the overrall economy…all bubbles must burst and take their due course. Good luck to all
September 8, 2007 — 5:07 pm
Brian Brady says:
John:
I have to point out that you are right- and you’re wrong. While LIBOR arms may skyrocket, a large percentage of ARMs are based of either:
(a)- the managed treasury average (MTA)- an index based on the average of the 1 year T-bill OR
(b) the cost of funds index (COFI)- the average of all the checking savings, and CD accounts for banks in NoCal, AZ, and NV.
Both of those indices will dramatically benefit from a Fed Funds drop.
Housing may drop but so will rates- the correctly prescribed ARM product will benefit a borrower dramatically in the next 3-5 years.
Good insight on LIBOR ARMs, John. Thanks for the input.
September 8, 2007 — 11:03 pm
Bob in San Diego says:
COFI has been a great Index and the MTA is dropping as well with investors looking for shelter in bonds. My option arm, which I have had since 2004, has capped and is now moving back down. It allowed me to manage cashflow when needed. It’s a fantastic loan for the right situation. Of course it helps if you now the whys and why nots of each loan option. Knowledge is power.
September 13, 2007 — 11:09 am
John Slocum says:
Hello Brian,
Thanks for your read on ARMs and the general direction on rates. On the macro scene, it’s been a tough walk for the Fed to manage the inflationary pressure that a large-scale overseas conflict plus the huge run up in petroleum prices cause; and not be mindful that the US Economy must have a healthy real estate industry — and reasonable interest rates on mortgages are essential.
On the personal level, ARMs with the right index, margin and period are a good choice, in my opinion.
September 16, 2007 — 3:43 pm
Ruth from La Jolla says:
You are becoming my favorite blogger. Thanks for all the great info.
December 3, 2007 — 12:32 am