RATE CUTS GIVE ONLY SOME HELP FOR ARMs

By Michael Braga, Bradenton Herald Tribune, Published: Monday, December 22, 2008 at 1:00 a.m.

The historic drop in interest rates will help some people whose adjustable-rate mortgages are scheduled to reset in the near future, enabling them to remain in their homes and avoid foreclosure.

Adjustable-rate loans tied to LIBOR, or the London Interbank Offered Rate -- the international interest rate that banks charge each other -- dropped to as low as 4.5 percent last week, while adjustable-rate loans tied to the one-year Treasury bond dropped even lower.

"People with adjustable-rate mortgages have definitely gotten some relief," said John O'Neill, chief executive of Sarasota-based Century Bank.

But O'Neill and others noted that the rate drops have done nothing to address a fundamental stumbling block in the housing market: Most people who sought ARMs during the boom did so with the idea of refinancing or selling their homes before their mortgage rates reset to higher levels.

When the real estate market ended its historic climb with a swoon, many owners found they owed more on their houses than they were worth. They began to ask whether it made sense to keep making payments.

"Half of the problem is interest rates and the other half is value," said Peter Lyddy, a mortgage broker with Gulf Coast Mortgages of Southwest Florida. "If people don't have the wherewithal to stay with the market and wait for home values to rise, then a drop in interest rates is not going to help them."

That said, the Federal Reserve's recent moves to reduce interest rates from 1 percent to virtually zero will provide temporary relief for those struggling to make payments.

For example, someone who got a $300,000 adjustable rate mortgage in September 2005 with a 3.85 percent introductory rate that was supposed to reset monthly to LIBOR plus 4 percent starting in September would now be paying an interest rate of 4.88 percent, or $257.50 more each month than he was paying three years ago.

Last month, before the Federal Reserve made its big move, that same person would have paid an interest rate of 5.45 percent, or $400 per month more than he was paying three years ago.
His savings from a month ago: $142.50. But calculating the potential savings across the entire economy is more difficult, mortgage brokers say, because interest rates on adjustable-rate mortgages, or ARMs, are impacted by a multitude of factors.

"There are a lot of different adjustable rate loans -- ones that adjust every month and others that adjust annually or semiannually," said Frank Fontanetta, president of Sentinel Mortgage in Sarasota. "Most people who have adjustable rate mortgages are being affected in a very positive way right now. Indexes are dropping and if they have mortgages that adjust monthly, they will see their payments drop next month."

How much payments drop depends on whether their loans are tied to LIBOR or Treasury bills or some other index, Fontanetta said. That is because all these indexes are adjusting at different speeds.

The LIBOR rate has been running high in recent months -- and during the financial crisis -- as banks have hoarded cash and worried that other lenders might collapse and not pay them back.
Meanwhile, the average rate for a conventional 30-year fixed mortgage on a owner-occupied, single-family home with 20 percent down on Friday was 5.375 percent, which is up slightly for the week from Monday's rate of 5.25 percent.

Ground zero

The problem with the adjustable rate mortgages offered during the boom is that they were issued to people with more of an investor mentality than a homeowner mentality, said Jack McCabe, a Deerfield Beach real estate consultant. Those people were expecting their homes to appreciate in value. When the opposite happened, they wanted out.

"Many will default regardless of how low rates go," McCabe said. "Their houses have lost 20, 30 and even 40 percent of their value and they do not know how long it will be before prices go up by 20 to 40 percent again. It could be several years."

It may make sense for some of these borrowers to default on their loans and allow their credit ratings to drop, he said.

The only way to avoid that would be for banks to allow homeowners to reduce the total amount of money owed to levels more in line with current property values, McCabe said.

"There will be no bottoming out until banks are willing to agree on principal reductions of loan balances," he said. "We need to reappraise every property, determine the percentage decrease in value and reduce the principal owed to the new value of the home."

If someone bought a house for $400,000 with 10 percent down and the house is now worth 200,000, then the lender should reduce the amount owed to $180,000, McCabe said.

"That will give the homeowner some equity that he can borrow against in the future to make other purchases," he said. "That is what has always driven our economy, and until that happens we are not going to see any improvement."

Jim Wright, a mortgage broker with Eagle Mortgage Company in Venice, believes homeowners will soon be able to do what McCabe suggests through the federal government's much maligned "Hope for Homeowners" program.

Launched by the Bush administration in October, the program allows homeowners to refinance their existing loans based on current market values with the understanding that their lender will share in upside appreciation when the real estate market recovers.

For example, if someone owes $300,000 on their house that is now worth $200,000, they could get a new $193,000 Federal Housing Administration mortgage, Wright said. In return for forgiving $107,000 from the previous loan, the lender would get the right to collect up to 90 percent of the profits from the sale of the house after the first year and 50 percent after five years.

"Getting 50 percent of the net proceeds is a better option for the lender than going through a short sale or a foreclosure," Wright said. "At the same time, borrowers are able to protect their credit and get lower payments."

The program requires a lot of work on the part of both mortgage brokers and homeowners because the homeowner has to prove that paying the current loan is a hardship, Wright said. The homeowner also must have a minimum credit score of 580 and a loan of no more than $417,000.

Few of these loans have been negotiated to date, but Wright predicted that changes will be made when Barack Obama becomes president.

McCabe is skeptical. "The program was projected to help 400,000 homeowners, but so far it has helped zippo" because banks have been unwilling to reduce the money they are owed, he said.
O'Neill, the Century Bank CEO, acknowledged that, too.

"We're not willing to take haircuts on principal," he said.

Century will do short sales, in which the bank agrees to receive less money from the sale of a house than is owed on the property.

It also will help borrowers by allowing them to make interest-only payments or run up the principal owed in return for lower interest payments.

"We are doing whatever we can to restructure and keep people in their homes," O'Neill said.
But the fundamental attitudes toward home ownership have changed and far more people are willing to default on their mortgages than they were ten years ago, O'Neill said.

"There is not as much sentimental attachment to a home," he said.

"People see it more as an investment, and if the investment has gone bad, they are willing to walk."