Recently I received a second offer in the mail to finance the purchase of a house using a low rate adjustable mortgage (ARM). My first reaction was to think, “Déjà vu.”
I just taught a Green River Community College continuing education class to people over 55 called “The Great Depression and the Great Recession of 2008: How Do They Compare?” One of the major causes of the burst of the housing bubble was the purchase of ARMs. Let me explain my concerns over this type of loan in relation to the 2008 housing meltdown. My source throughout is The Complete Idiots Guide to the Great Recession. (I highly recommend this book if you want to study more about what happened to create the Great Recession.)
ARMs were created in 1982 to make borrowing easier. The advantage was low interest rates for the borrower. The Federal government wanted people to be able to buy homes because it spurred the economy. Once Americans moved into a new home they were likely to fill them up with washers, driers, refrigerators, and furniture. These purchases would further spur the economy, especially in the real estate industry, banks, construction, and insurance companies, creating jobs and wealth in a ripple effect.
As long as the rates were low the borrower could save a lot of money. The problem was what happened when interest rates began to climb. Instead of paying 1% as many were in 2003 the borrower might be paying 6.25 percent by 2007. Many poorer homeowners were financially squeezed by these increases.
Since many lending institutions had cut and bundled these sub-prime loans into securities and sold them to often unsuspecting investors, there was no sense of accountability for being careful about whom these banks should lend to. The incentive for the lending institutions was to make as many loans as possible, the riskier the loans the higher the commissions, and pass them on to some unsuspecting purchaser who would suffer the loss if these loans defaulted, which they did. This increase among sub-prime (high risk borrowers) mortgages caused loan defaults to reach a high of 80 percent between 2006-2007.
These sub-prime failures rippled through the economy like the tsumani that hit the coast of Japan in 2011.
So, why do we still have ARMs? The answer is because neither the Republicans nor the Democrats have done much to avoid another 2008 financial meltdown. Why not? There are several reasons, but the one of the biggest is that financial institutions have used their vast wealth to hire lobbyists and provide campaign contributions to elected members of the Federal government. What’s to keep another greedy economic rampage from occurring again in a few years? Only the memory of what happened in 2007 and 2008. And greed will have no check as the memory of the Great Recession fades.
Think very carefully whether you can afford an ARM to finance a major purchase. If you don’t have the money to cover the rate increases when your lock period ends, don’t get an ARM. When loan officers say, “As your income rises…” be very careful because pay for middle-income workers has been stagnant for over 30 years!
Richard Elfers has a masters in history from Pepperdine University. He is a former Enumclaw City Council member. He is currently an adjunct history and current affairs professor at Green River Community College.