In so many articles about the housing and mortgage crisis in the United States, adjustable rate mortgages (ARMs) are invariably mentioned as one of the culprits. People can’t pay when the interest rate on their loan resets. The words ARM and dangerous are often used in the same sentence. Should ARMs bear the blame though? I linked to the mortgage loans offered by a Canadian bank in a previous post. There are no fixed rate loans in Canada. All they have in Canada are ARMs. If ARMs cause mortgage loan defaults and foreclosures, Canada would be in constant chaos.
As a follow-up to my post two weeks ago about understanding the world, I decided to expand my horizon beyond North America and take a look at mortgage loans in some other countries. Thanks to the power of the Internet and Google translation tools, I can do this relatively easily. I only limited my primitive research to developed countries. In each country, I picked a random bank, which should represent the available mortgage products in that country. I got the names of the banks from List of Banks in Wikipedia.
Canada – CIBC. No fixed rate loans. ARM and hybrid ARM with rate fixed up to 10 years. Refinance or take variable rate after the fixed rate period is over.
Britain – Halifax. No fixed rate loans. ARM and hybrid ARM with rate fixed up to 10 years. Refinance or take variable rate after the fixed rate period is over. When guests on the FT Money Show podcast talk about a “fixed rate” mortgage, they are actually talking about the rate fixed for 2 years; otherwise it’s a “tracker” mortgage.
France – Societe Generale. Fixed rate loans up to 30 years. ARMs are also available.
Germany – Hapsa. I can’t find rate quotes online but it looks like you can have a fixed rate loan for up to 15 years. ARMs and interest-only loans are also available.
Japan – Mizuho. Fixed rate loans up to 20 years. ARMs are also available.
Australia – ANZ. No fixed rate loans. ARM and hybrid ARM with rate fixed up to 10 years. Refinance or take variable rate after the fixed rate period is over.
You see the 30-year fixed rate mortgage in the United States is an exception, not a rule. Only France has 30-year fixed rate loans. The other countries don’t. ARM and hybrid ARM are the norm in other parts of the world. In many countries you also can’t refinance a hybrid ARM during the fixed rate period, whereas the hybrid ARMs in the U.S. typically can be refinanced at will. Americans still have it much better than people elsewhere.
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Ben says
Another concept that interests me is how the loan is securitized. I have been led to believe (perhaps incorrectly?) that if you default on a mortgage from most (all?) USA banks, you are not liable for anything more than the *sale price* of the house. This obviously creates a big downward spiral as house prices plunge.
In New Zealand (where we too only have ARMs fixed for up to 5 years), if you default on your loan, and the house goes to mortgagee sale, the bank can still chase you for any amount not covered by the mortgagee sale.
You could argue that most mortgagees will have difficulty paying the remainder, but even if the bank recovers cents on the dollar it is better than nothing.
Neil says
The thing that’s missing in this analysis is that all of these countries with ARM loans have ARM loans with rate fixed up to 10 years. That makes a big difference. The ARM loans the American consumer got were 2 YEAR ARM loans, which means they have to turn around and refinance, or else they’re stuck with a HUGE jump in monthly payment. So it’s basically a gamble: as long as the price of houses remains the same or goes up, they’ll be able to refinance, since they’ll owe less than the house is worth. But if the price of houses drops, as it did, then they’re stuck with a high-interest loan that they can’t pay off.
A 10-year fixed rate ARM is a totally different beast, and gives the consumer 10 years to refinance, which allows for fluxuations in the housing market without the consumer being stuck with a high-interest loan.
Ben says
Neil, in New Zeland, 2-3 years is the standard for most mortgages, and there has never been a huge rush of foreclosures.
I think one massive difference with USA ARMs, is that the initial fixed rate is often at a huge discount, leading people to believe incorrectly that they can afford a mortgage *at all*, fixed or otherwise.
Neil says
Yes, you’re right, the huge discount is the problem. This is why I say it’s a gamble: people can afford the mortgage with the huge discount; and, if they refinance to a standard mortgage after making payments for two years (and establishing good credit), they can afford the refinanced mortgage. But if housing prices drop; or mortgage rates rise, then they’re stuck with the “gotcha” rate. So, yes, the deep discount combined with the high post-two-year rate is the problem.
At the same time, my point still remains that having a 10-year-fixed ARM makes a HUGE different, and gives the consumer a lot of time to refinance, regardless of interest and/or home price fluxuations. (It also gives them time to pay down their mortgage so that they can refinance even if home prices drop.)
Thus, the kinds of loans Americans got WITH 10 years fixed would be OK; or a 2-year-fixed without a large “gotcha” interest rate after two years would be OK; but a two-year-fixed with a large “gotcha” interest rate would not be OK.
Harry Sit says
Neil – 10-year fixed ARMs are also available in the United States. For example, if you go to Mortgage.com (part of Citi), in the Select a Loan Type dropdown, you will see 3/1 ARM, 5/1 ARM, 7/1 ARM, and 10/1 ARM. People could’ve chosen 10/1 ARM if they wanted to.
Ben – Thanks for the info about mortgage loans in New Zealand. I just looked at the rates at ANZ. A 2-year ARM is 8.70%! A variable rate loan is 10.45%!! Americans definitely have it better.
Ben says
TFB: I think you mean “Americans definitely *HAD* it better”. Unfortunately you appear to be paying for the cheap credit right about…. now.
🙂
Neil says
TFB: “People could’ve chosen 10/1 ARM if they wanted to.” Not necessarily so. People with bad or less than perfect credit can sometimes only get a two-year ARM (the idea being that they’ll either refinance if their credit improves, or the bank will get higher interest).
So the problem comes back to people with “sub-prime” credit getting loans that ended up hurting them when the 2-year ARM transitioned to the higher rate, and they were unable to refinance because the housing market had dropped.
So, yes, for people with good credit, an ARM loan is not a problem, and they could probably get the 10-year ARM. But for people with sub-prime credit, the problem remains the 2-year ARM, which gave them the impression that they’d be able to refinance and avoid the higher rate/payment, but they were unable to.
So my point remains — either a 10-year ARM with the big gotcha rate, or a 2-year ARM without it, would have been fine. But the 10-year ARM wasn’t available to people with sub-prime credit.
So is the problem the people with sub-prime credit or the 2-year ARM with the high 2nd-tier rate? Well, both. The 2-year ARM is what enabled them to get the loan that they wouldn’t have gotten anyway, and caused them to default on their mortgages when the housing market dropped and they couldn’t refinance.
Danielle says
So here’s my question for the non-US mortgage holders. Do people normally pay off their mortgage in 10 years or do people refinance another 1 year term?
Oh and FWIW, my friend in Russia bought a house with 4 equal cash paymenta as a “mortgage” paid off in one year. I wonder if that is typical in Russia.
Patrick Trombly says
Canada didn’t have much of a bubble because its adjustable rate mortgages are based on their five year rate, not their one year rate, and the five year rate didn’t move much.
ARMs are based on an index.
In the US that index is, or follows, the federal funds rate. I.e., cost of funds, LIBOR, etc….
The Fed sets the federal funds rate.
The federal funds rate is – or, was, until the financial crisis – the primary, in fact almost the only, policy tool in perpetual use to control growth of the money supply.
The federal funds rate shifts relative to longer indices, say, the ten year constant maturity (again, up until 2008), as a function of whether policy is “stimulative” or not, and the degree of “stimulus.”
So, ARMs are “dangerous” only in that they expose borrowers to the volatility of Fed monetary policy.
To blame ARMs is to blame the Fed – or at least, to make it the banks’ responsibility to, once the Genie is out there, put her back in the bottle.
Mortgages are 30 year amortizing loans. They’re incredibly rate sensitive.
Home purchases are financed at very high loan to purchase price ratios. So, home prices are incredibly rate sensitive.
The Fed’s 2001 rate cuts enabled a given income to service a 60% bigger mortgage.
ARM share of purchase originations rose by orders of magnitude.
The same thing happened in a few dozen jurisdictions.
Because the ECB did the same thing.
Not all those jurisdictions had securitization or subprime.
But all had short-rates on their mortgages.
German mortgages are structured on a 10/25.
Germany’s 10 year rate didn’t move much after Germany joined the EU.
Germany didn’t have a housing bubble.