Housing Finance Debate: A Return to ARMs?

They were one of the scourges of the housing crisis, but are adjustable-rate mortgages on the verge of a comeback?

It depends on whom you ask.

Last week homebuilder Toll Brothers announced that, in certain housing markets, it would offer its homebuyers ARMs featuring a 3.75 percent interest rate for the first seven years of the loan and a reset rate capped at 8.75 percent for loans at or below $417,000. To qualify, home buyers must have credit scores of at least 720.

Don Salmon, the chief executive of TBI Mortgage Company, Toll Brothers' mortgage division, told ABCNews.com that on the weekend following the announcement, the homebuilder saw a spike in interest that's unusual for the typically slow summer season. Other homebuilders and lenders, he said, might follow Toll Brothers' lead.

"If the product makes sense to the consumers, then consumers will demand it (and) then the lender will offer it," he said.

But others, like Bankrate.com senior financial analyst Greg McBride, are skeptical.

"People have been scared away from adjustable-rate mortgages and at the same time, the factors that led them to pick adjustable rate mortgages in the first place have dissipated," McBride said.

As of July 10, roughly 5 percent of borrowers chose ARMs, according to the latest data from the Mortgage Bankers Association. That represents an uptick from earlier this year but it's still far from the highs last seen in the summer of 2007: At that time, more than one in five borrowers chose adjustable-rate loans.

Toll Brothers' rate notwithstanding, McBride said the average interest rate for 7-year ARMs is 5.55 percent -- just 0.2 percentage points lower than the average rate for a 30-year fixed loan.

"The value for the overwhelming majority of homeowners is in fixed-rate mortgages," he said.

Adjustable-rate mortgages, McBride said, were a niche product that became popular during the housing boom as buyers used them as an "affordability crutch" -- in other words, buyers who might not have been able to afford the rates on a traditional, 30-year-fixed mortgage could qualify for with the lower initial rates on adjustable loans.

While the housing market was strong, many homeowners with ARMs figured they could sell their homes before their interest rates reset or refinance into fixed-rate home loans.

Those assumptions often proved false and defaults by adjustable-rate mortgage homeowners -- particularly for homeowners with bad credit who took out subprime adjustable-rate loans -- played a key role in driving foreclosures to record highs.

An 'Iron Stomach' for ARMs

McBride said that a homebuyer today would be foolish to assume they could find a bank to refinance them out of an ARM. And taking the bet that you'd be able to sell your home before the reset requires a "cast iron stomach," he said.

Banks and investors who buys home loans from lenders aren't keen on ARMs either, McBride said.

"The secondary market been dead for a couple of years," he said.

Salmon says that Toll Brothers, however, won't have trouble selling its ARMs. The delinquency rate for Toll Brothers borrowers, he said, is less than 1.7 percent. The homebuilders' underwriting standards -- including the 720 credit score minimum -- are prudent, Salmon said.

"We have a very strong buyer profile and our delinquencies historically are lower than the market, therefore our product is more attractive to banks," he said.

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