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Should Adjustable Rate Mortgages Be Outlawed?

By Sammy of Stone Marmot

Dec. 13, 2008

The US government is presently handing out trillions of dollars to financial institutions and homeowners with delinquent mortgages in an effort to keep the economy from collapsing. So far, the government is only fighting the symptoms. They haven't done anything to address the main cause of today's economic problems: The adjustable rate mortgage (ARM).

Many people apparently don't understand what an ARM is. An adjustable rate mortgage is just what it says it is, a mortgage with an rate that is adjustable, that is, it is not constant. The monthly mortgage payments goes up and down as the average market interest rates change.

Many people got ARMs in 2001 through 2004 when interest rates were the lowest since the Great Depression. Then in 2005 to today, when interest rates started going back up towards the historical long term average, many of these same people were finding their mortgage payments increasing dramatically to more than they could afford.

Why did they get an ARM and not a fixed rate mortgage? In many cases because they could not afford the house they wanted with a fixed rate mortgage. In other words, they were trying to buy a house they couldn't afford. So they tried to deceive themselves into believing they could afford it by getting an ARM, ignoring the fact that since the prevailing mortgage rates at the time were exceptionally low, the ARM rates, and their mortgage payments, were probably going to go up dramatically in the future. They gambled, they lost, and now everyone else is paying for their stupidity and recklessness.

ARMs made some sense when they first started to become popular in the early 1980's. Interest rates at that time were over 10%, and peaked around 16%. A lot of people didn't want to lock in for 30 years a fixed rate mortgage with so high a rate, so they decided to wait until rates dropped. Unfortunately, this caused a slow down in the housing market. So, in an effort to keep the housing market going, many financial institutions started offering ARMs. This enticed a lot of people back into the market, since they would now only be paying these high rates for a short time until the interest rates fell to more reasonable levels without having to refinance their mortgage. And interest rates at that time were expected to go down from these exceptional high rates, and they did.

But the situation this past seven years has been just the opposite: Rates were exceptionally low and were expected to go back up (and they did). But a lot of people getting ARMs ignored this possibility. Until recently, this would not have been a problem, since the mortgage issuer would not accept an applicant who was likely to get into a situation where they could not make the mortgage payments. But recently many mortgage issuers weren't keeping the mortgages but were instead selling them to others. And the people buying these mortgages weren't diligent in checking that all the mortgages were proper.

The US government is doing nothing to address this issue. In fact, the steps the government is taking to keep the economy going actually encourage this kind of behavior, since they are bailing out most of the people who made these mistakes. The government is letting people who bought houses they couldn't afford keep their houses. This sends the message to the rest of us that we should also do the same.

Since many people are too stupid, naive, or greedy to properly handle ARMs, ARMs should be prohibited. Any company being bailed out should be forbidden to issue any new ARMs as a condition of being bailed out.

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