ARMs and I/O Loan Changes

A new wrinkle has been introduced to ARMs and Interest Only loans that will have a huge impact on those wanting to use these instruments. Going forward a borrower will be underwritten on the payment associated with the highest possible payment. This is a major change as for the most part borrowers have been underwritten using the start rate until now.

These changes are significant in that now a borrower must qualify for a a short term conventional ARM ( less than a 5 year fixed period ) on the greater of the fully indexed rate or the current note rate +2%. Today that means a borrower that wants a 3/1 Intermediate Term ARM that has a rate of 3.5% will have to qualify at 5.5%, a rate that is 1/2 % above the current 30 year fixed note. My experience of late has been borrowers wanting to use these loans have an exit strategy that will occur well before the reset. Plus they are financially savvy enough to manage their money and understand all the implications of their choice of product.

I/O loans are being made over as well. Higher minimum FICO scores to qualify ( 720 ) and a whopper of a requirement of having up to 24 months in payment reserves after cash to close is accounted for. I/O loans have already been pretty well beaten up with other restrictions in the recent past that have made them look like an ugly step child anyway so I can't believe that this new requirement will do much in terms of people not qualifying.

All these changes are really designed to ensure that the borrower has a true capacity to repay the loan. But in the case of the I/O changes I have to believe it is the beginning of the end for these products. Just like the first changes to PayOption ARMs and 2nd liens to 100% CLTV  the requirements are becoming so restrictive no borrower will want to monkey with them. As always Freddie Mac will eventually follow Fannie Mae, sooner or later.

No surprise to those of us in lending that these have been instituted. These are a continuation of the mandate that borrowers show a capacity to repay a loan, just like the good ol' days. Plus Fannie and Freddie have to find new ways to keep their income up from new loans to make up for the fact they are losing their asses on all the bad ones they ate up in the 2000's.