One Example of How an ARM Loan Isn't All That Toxic

I recently received my ARM notice from Aurora Loan Services that my interest rate was going to adjust in 30 days.  

Remember ALS?  It was the savings bank owned by Lehman Brothers that pioneered the Interest Only Stated Income Loan. This is the type of mortgage many claim to be one of the toxic loans that helped create the mortgage meltdown and subsequent recession. 

Why in the heck did I get one of these mortgages? 

Let me explain.

In 2003, my wife and I started a major remodel on our 100 year old house and needed to borrower $300K to help pay for the cost.  At the time, we had no loan on the house and ALS was offering cash out refinances on several loan programs up to 80% of the current value.  Though we were going to use the money to remodel our house, the proposed loan was still considered a cash out refinance.

I reviewed our mortgage product options..

We looked at a 30-year fully amortized fixed rate mortgage at 5.25% or a 5-year hybrid ARM at 3.875, converting to an adjustable mortgage after the 60th month, with the floating rate based on the 1 month LIBOR plus a 200 basis point "margin".  The hybrid loan was also interest only for 10 years.  I’ve always financed our homes with fixed rate loans and felt a little uncomfortable taking an ARM.  However, I felt lucky that day and bet on the hybrid ARM.  The lower rates would lower my payments and I believed I could refinance later when I got close to the first adjustment.

Just before my first adjustment, the mortgage meltdown unfolded.  Liquidity dried up for hybrid ARM loans that had IO and stated income features.  Here I was a seasoned mortgage hack with limited refinancing alternatives to take out my soon-to-be adjustable rate mortgage.  In the end, I waited for the ARM adjustment to see how much my interest rate would rise.  At the time, there was no liquidity for non-conforming loans and LIBOR rates were much higher than US Treasuries.  

My rate did adjust, but to my surprise it ended up dropping to 3.75%. At the next adjustment, which would occur 6 months later, it dropped again, this time to 2.87%. At my next adjustment my rate is scheduled to drop to 2.75%.  

So why am I sharing this story?  Not all ARMs are the demonic and toxic  products described by talking heads, congress and regulators.  Over a six year period I saved $39,750 in interest, paid down my mortgage $30,000 from the savings and spent the rest to help support the economy.  

It’s true an inverted yield curve would have resulted in a much higher rate today and my overall savings would have been reduced.  However, inverted yield curves don’t last very long.  I found a site that looked at an 80 year history of inverted yield curves and it showed they occurred only 8 years out of last 80 years (study done in 2007).  If this is true, are ARMS with realistic margins really that toxic?