Why don’t mortage companies who have lended ARM mortgages just convert the loan to a lower rate fixed?

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Just wondering in the whole backwash of subprime lending and ARM loans recently going under, why havent mortgage companies investors just lose less by converting those mortgages to a lower fixed rate to save the company, the consumer and the US economy? Many mortgage companies are out of business now, at it seems if who is left can at least cut some of their losses, it would be good for all.

Please no stupid bashers, I want financial experts to explain this to me. I don’t have a mortgage, but would like to buy a house in the near future. I have no degree in business so I havent a clue what this entails.

Thank You

  1. Reply
    Greg S
    January 30, 2011 at 10:40 pm

    I work for one of the largest mortgage lenders / thrifts in the country. As a lender we make profit by pricing your loan for risk based on our margins (profits we sell our loans for to our investors or banks).

    An ARM loan is typically priced lower than a 30yr fixed rate. The reason is the length of exposure to the investor who ultimately purchases and/or services your loan (collects payments) is a lot shorter. Once loan is sold off you can “re-lend” the money out again.

    Or if the loan “adjusts” to current rates, the investor makes money at a current rate of interest.

    30 years is a long time and lots of things can happen to the market and the individual. If you are an investor, why would you want to lock up your money for 30 years when you can keep lending every 2 years at a decent rate? Theoretically, lets say the mortgage interest rates climb back to where they were in the late 70’s/early 80’s (15%). 10 years from now you are holding this mortgage note (as an investor) at 7% while everyone else on the block is buying loans and collecting 15% interest. You are losing money at that point.

    As far as mortgage companies out of business, the issue has to do with “liquidity” not so much loan defaults. Most banks must “sell” their loans to investors to free up their capital so they can keep lending it out over and over again. They make money each time they sell a loan depending on the interest rate “future value” of the note. Recently, Wall Street investors have stopped buying these loans so lenders are unable to create “new capital” to lend out once again. I work for a bank so we borrow from the Fed. We also lend out deposits from our bank branches. Other lenders are up a creek.

    Once the loans are sold to investors, the “lender” doesn’t really care if they convert to a fixed, ARM or whatever. They made their money. Some banks/lenders “service” the loans (collect payments) and make money doing that which comes out from the loan proceeds (they collect payments on behalf of the investor who pays them a little bit extra out of each loan they purchase).

    “Whole loans” are also rarely sold on the market. Most loans are sliced/diced into pension funds, mutual fund companies, etc. Technically, ten people could “own” a “piece” of a loan. This spreads the risk around.

    The problem is there is a lot of fraud in the mortgage market. Many people qualified for loans they cannot afford. If they can’t afford a short term ARM rate (interest only) they’ll never be able to afford a 30 yr fixed payment. There is no incentive for a lender to “re-write” loans. It’s easier to go out of business….

    Also, due to lots of fraud, the investors are forcing the “lenders” who made the loans to “buy them back” under their purchase agreement. Basically if someone defaults on their first payment or the investor finds fraud, the lender must buy it back. Many lenders do not have enough cash put aside so they just buckle. The same thing happened about 10 years ago.

  2. Reply
    Casey C
    January 30, 2011 at 11:02 pm

    Greg S is right on. To summarize for him:

    1. Banks are not at liberty to change the terms of customers loans because they are not the owners of the note. Many banks that have not sold their loans actually do exactly what you suggested. Wells Fargo Financial, a small branch of Wells Fargo holds all of their loans and have the capability to convert these loans.

    2. Banks are going out of business because they were unable to sell their most recently booked arm loans and don’t have the capital to hold and service the loans.

    3. People stopped buying these loans because the ones that started to roll in masses 2 years ago have all defaulted and the rate of return is no longer there.

    You make a great suggestion and trust me, if banks have the capability to change the terms of their loans with clients to keep it from going into foreclosure, they certainly are doing everything they can.

    If you have further questions or you need a loan yourself, you can contact me casey.x.casperson@chase.com or caseycasperson.com to verify I’m not some crazy guy answering questions.

  3. Reply
    January 30, 2011 at 11:55 pm

    If a loan officer puts a person into an A.R.M. without a specific and good reason then I call them Con-officers.

    I am a Mortgage Planner so my goal is to fit the loan to the persons needs. If you come in and tell me that you are moving in 4 years (ie-military). Then a 5 year A.R.M. is a good choice.

    If you plan to live in that house for an indefinite period of time, then a fixed rate mortgage is probably best for you.

    The reason the mortgage companies will not just convert the variable rates to fixed rates is because it is big money for them. In two years on an A.R.M. you are not going to reduce the principal on your loan amount enough to cover the cost of the refinance to the fixed rate.

    In other words, after 2 years on an A.R.M. You may have to borrow more money for the second loan than for the first loan in order to cover the closes expenses.

    Refinancing a home is expensive and you don’t want to do that more often than about 5 years and then I advise my clients that when they refinance in 5 years they should try to reduce the years that they are paying by 10.

    Example: First time home buyer — I put on a 30 year fixed rate. After 5 years they need a bit of debt consolidation and home improvements. They come to me and re-do their loan. We restructure and then refinance for 20 years.

    If they are in a pretty solid financial place I suggest that they may want to re-finance with cash out for investments.

  4. Reply
    January 31, 2011 at 12:09 am

    Adjustable Rate Mortgage

  5. Reply
    January 31, 2011 at 12:36 am

    Adjustable rate mortgage. That means your interest rate is not fixed over the life of your loan. It can be raised and your payments can sky rocket without notice. Go for a fixed rate loan!

  6. Reply
    January 31, 2011 at 1:03 am

    An Adjustable Rate Mortgage.

    The interest rate, and hence the monthly payments, fluctuate over the period of the loan.

    With this type of mortgage, periodic adjustments based on changes in a defined index are made to the interest rate. The index for your particular loan is established at the time of application. Some well known ARM indexes are here:


  7. Reply
    January 31, 2011 at 1:41 am

    All mortgage loans are not created equal. If you are looking for a loan, you have probably discovered the array of loan types and options. It can be confusing forthe first-time borrowerand are easier to qualify for than conventional loans. They are also guaranteed to the lender, which allows the borrower to obtain more favorable loan terms.

  8. Reply
    January 31, 2011 at 2:40 am

    An Adjustable Rate Mortgage (ARM) is fixed for the beginning of the loan for a set time (2 yrs is common). After that the rate can readjust every 6 months. Typically the ARM is linked to the LIBOR index and will be the LIBOR + x amount of points which equals your interest rate for the next period. You’re rates minimum will be the beginning rate and there is a maximum it can be. Discuss and research thoroughly. The advantage to an ARM is if you can pay all those fixed payment on time, then you can refi before rate adjusts. However, noone know where interest rates will be in that 2-3 year period. So buyer beware there. Also, don’t think that when the feds lower interest rates it will affect your ARM or your mortgage rate. Mortgage interest rates are based on the bond market, not the feds and many people are unaware of that – something to keep in mind in deciding whether or not to do an ARM.

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