The Death of the 2/28 ARM

Five out of six of the largest sub-prime lenders have pulled the plug on the 2/28 Adjustable Rate Mortgage (ARM), the one time favored product that has come under harsh criticism from private consumer advocate groups and Congress in the recent months.

I have had numerous people in the last year come into my office trying to refinance off of this product. Many had already gone through the first adjustment of the loan and were stunned by the amount their payment had increased by. Others had just gotten their notice about about the interest rate change and some were trying just to get out as soon as they could before anything happened.

The allure of the 2/28 is simple. It gives a competive rate and can help many credit challenged borrowers get into their new home. It does this by offering a short term fixed rate, which are the first two years, then can adjust either annually or every six months. Most of the 2/28 ARMs I have seen also have a pre-payment penalty associated with them. The pre-payment penalty normally covers the initial two years of the mortgage. I have seen a few that have actually had a pre-payment penalty that exceeded the initial fixed portion of the loan by a year. Talk about a double whammy.

Good in principle, Bad in practice

The idea of the 2/28 ARM is fine. The product helps those with weaker credit get good rates . The goal of this loan is to get the borrower into the home and gives them two years to get their credit straightened out so that when the adjustment time comes their credit scores have rebounded to the point where they qualify for a traditional prime rate mortgage. The issue arises when looking at how the product was utilized during the height of the boom. Loans using stated income or no income verification came into vogue which makes these loans even more dangerous. If you aren't verifying to see if the person can really afford the new house payment, you are setting them up to fail. The fault lies with everyone involved in the loan. The lender is trying to write as many new loans as it can before the market changed (everyone knew the boom couldn't last forever), the originator was pushed by the lender, the buyer, and money, and the buyer was at fault because they should have known better than getting into a home they couldn't afford. I know that some people were ruthlessly taken advantage of. I have run across my share of those unfortunate souls. But a vast majority of the people in this position did it because they wanted to take part in the party. Most knew that they were in ARM loans, they just thought everything would turn out alright in the end. They wanted to own their own home rather than rent. They wanted to upgrade. Whatever the reason they did it, they still took an active part.

I'm not blaming the borrower for this mess, far from it. It is the lender's responsibility to make sure the borrower knows both the pros and the cons of doing an ARM loan. But many originators/brokers are more interested in completing all the loans they can. Those of us who care more than about money have had loans approved that we have thought in our head, "We are going to end up with this house back." But when a loan is approved, it's approved. It's then up to the borrower to make up their own mind if it's in their best interest to make the loan.