21 June 2017

Right, But For the Wrong Reason

Yet another story on the vampire loans, ARM. They've come back from the dead. What's interesting about the story is that it gets the reason for using ARM (from the house buyer's perspective, of course) completely wrong.

The folks who are the best for ARM are the Yuppy. Or, for that matter, anyone with strong expectations of rising income, especially above the expected inflation rate. If you're setting out to flip the house, as was the come-on which led to the Great Recession, then we'll just have another one. Those with rising incomes can chose to either flip or stay when the interest rate ratchets; everyone else has to sell, no matter what. We do all remember that was the proximate cause of the Crash. Don't we???? That CBS News would allow such a knucklehead to write such drivel is disturbing.
According to a study by the Federal Reserve, ARMs are a play on rising interest rates. When rates are low, as they have been for many years, homebuyers prefer a fixed-rate 30-year mortgage. But the Fed is gradually raising interest rates due to an improving U.S. economy.
[my emphasis]

Of course, this is nonsense. What matters in capital purchases, specifically consumer ones, is the monthly nut. Keep the nut (monthly mortgage plus fees) to some mythic percent, say 25% of gross income. Only those with rising incomes can withstand mortgage payment resets. Non-earned equity in that bungalow happens when the market value of the bungalow rises above the remaining mortgage value. Simple arithmetic. Just what the marginal flipper is expecting; a few years in a McMansion, then sell it out. Same as 2005. Some other simple arithmetic: what happens to capital values when interest rates rise? Class???? They fall, to match the implied return, which has gone up. What happens to house values as interest rates rise? Class??? They fall so as to keep the nut stable. So, what happens when ARM mortgages, held by those on stagnant or falling wages, rise? They all have to sell or be foreclosed. We've really have seen this movie before. Gad. So, for the house buyer, ARM in a time of rising rates is the absolutely worst time to sign on the dotted line. Except for the truly upwardly mobile. Given that the middle class is in rapid decline, what's the answer? Class???

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