Since the mortgage domain—and the nation—went into a tailspin a decade ago and tons of borrowers lost their homes, adjustable-rate mortgages (ARMs) have got a bad rap. Sordid history aside, the ARMs offered now are head and shoulders above the previous models, says First American in its February 2018 Loan Application Defect Index.
“Today’s ARM is not like those of the past,” said Mark Fleming, Chief Economist at First American. “It is essentially the same as the 30-year, fixed-rate mortgage with one difference: Rates adjust after an initial fixed period of usually five or seven years.”
Retooled characteristics aside, though, will the comeback of these previously scorned products give rise to surging loan application defect risk?
“ARMs historically have had more defect, fraud, and misrepresentation risk than the traditional 30-year, fixed-rate mortgage,” First American said. “Interestingly, that has changed recently. Adjustable-rate mortgages, based on our defect, fraud, and misrepresentation index, are modestly less risky.”
Now that we’re in a rising interest rate environment—a 30-year, fixed-rate product currently is about 4.5 percent and expected to reach 5 percent by year-end—ARMs are looking more attractive. With a current rate of 4 percent, borrowers wanting to keep their payments lower are likely to reach for an ARM, First American says.
Based on its risk analysis, that might not be such a bad idea, the company notes.
Its Defect Index showed that in January, the frequency of defects, fraud, and misrepresentation in the information provided in mortgage loan apps stayed the same compared with the previous month.
Compared with February 2017, the index rose by 9.2 percent but is down 18.6 percent from the peak risk point recorded in October 2013, First American reports.
For refi transactions, the index remained flat compared with the previous month and is 13.1 percent higher than a year ago. As for purchase transactions, the index dropped by 1.1 percent compared with the prior month and is up 7.1 percent compared with a year ago.
“As mortgage rates continue to rise, the share of adjustable-rate mortgages is also likely to increase and, if current defect risk patterns hold, will offset some of the increased risk the market will bear as it shifts to purchase transactions,” First American said.