MortgageNewsDaily.com - Even though the media has depicted Adjustable Rate Mortgages (ARMs) as one of the many toxic loan products that contributed to the financial meltdown, consider the example of C.M. "Corky" Watts, principal at Garrett, Watts & Co., a mortgage bankers' consultancy in California.

While not your average borrower, Watts' story does illustrate how an ARM mortgage product can work to your advantage.

"In 2003, my wife and I started a major remodel on our 100 year old house," states Watts, "and needed to borrow $300K to help pay for the cost. At the time, we had no loan on the house."  Watts intended to do a cash-out refinance.

According to Watts, he reviewed his mortgage product options. "We looked at a 30-year fully amortized fixed rate mortgage at 5.25%" and then considered a "5-year hybrid ARM at 3.875%." The ARM converted to an adjustable mortgage after the 60th month, with the floating rate based on the 1month LIBOR index plus a 200 basis point "margin".  The hybrid loan was also Interest Only (IO) for 10 years. 

"I've always financed our homes with fixed rate loans and felt a little uncomfortable taking an ARM," Watts exclaimed, but "the lower rates would lower my payments and I believed I could refinance later when I got close to the first adjustment. I felt lucky that day and bet on the hybrid ARM."

Just before his first adjustment the unpredictable happened; the mortgage meltdown unfolded.  "Liquidity dried up for hybrid ARM loans that had IO and stated income features," continued Watts, and there were "limited refinancing alternatives" to take him out of his "soon-to-be adjustable rate mortgage."

At this point you might be asking the same question Watts posed, "Why in the heck did I get one of these mortgages?"

In the end, Watts decided to wait for the ARM adjustment to see how much his interest rate would rise.  At the time, there was no liquidity for non-conforming loans and LIBOR rates were much higher than US Treasuries. 

"My rate did adjust, but to my surprise it ended up dropping to 3.75%," Watts exclaimed. Six months later his next adjustment was due and according to Watts, "it dropped again, this time to 2.87%." Watts received notification a couple of weeks ago about his next upcoming adjustment date and "my rate is scheduled to drop to 2.75%."

"So why am I sharing this story? Not all ARMs are the demonic and toxic products described by talking heads, congress and regulators," offered Watts.

"Over a six year period I saved $39,750 in interest, paid down my mortgage $30,000 from the savings and spent the rest to help support the economy."

"It's true an inverted yield curve would have resulted in a much higher rate today and my overall savings would have been reduced.  However, inverted yield curves don't last very long," states Watts.

Borrowers should be encouraged to ask the question, "Are ARMs with realistic margins really that toxic?"

Homebuyers should carefully consider their own personal financial situation and discuss their long term goals with an experienced mortgage banker when considering an ARM or any other mortgage product for that matter.

An ARM's initial lower interest rate can increase your buying power and could be the deciding factor in securing your next mortgage.

Link: ARMs