Open House Picks: Six Months Later

Many of the recent condo sales I have looked up on ACRIS have been financed with a fixed-to-floating ARM product (fixed rate for something like first 5 or 7 years and floating after that). I have not looked at the papers for recent brownstone purchases in Brooklyn but without the benefit of any of my own research I have been led to believe that the same product has become pretty popular among high earners in the NYC finance world buying all kinds of properties. When I call mortgage providers/brokers and tell them I am only interested in 30-year fixed products they seem genuinely surprised. Perhaps Adam Dahill can give us some thoughts.

ARMs are not necessarily a bad for all people. They are just fine for a certain portion of the population. The problem is that people like to convince themselves that they are in the minority even though most aren't (sort of like how almost everyone's kids are above average). It's easy to convince yourself you are financially sophisticated if the immediate result is lower monthly payments (for now). I know a lot of people with ARMs and can't think of a single one of them I consider financially savvy enough to have that product.

Posted by: lechacal at April 3, 2009 1:18 PM

OK, here is a brief discussion of why ARMs are a bad product for most (but not all) people.

1. The rate on ARMs can go up or down. Subject to limits on annual increases, the rate can go up a lot. Some ARMs are even designed to go up significantly after a "teaser" rate expires.

2. For various reasons it is human nature, particularly in New York, to buy as much apartment as one can possibly afford.

3. When deciding how much they can afford, people seldom give serious consideration to what will happen if the rate goes up significantly. They just think to themselves, "well, the broker told me the initial monthly payment will be $6,500, so I'll just plug that into my budget and -- well, it's real close, but I can do it!"

4. Inevitably, at some point, rates will increase above that initial montly payment that so many people used in their budget process.

5. A great many of those people, particularly in this environment (where earnings are not increasing and they can't sell to get out), will lose thier shirts.

6. Many of these people did consider the possibility of higher payments, and just assumed they could refinance into a fixed rate or sell if their rate went up. Both of those assumptions could prove terribly wrong.

My advice is as follows: If you can't buy a property with at least 20% down and a 30-year fixed-rate mortgage, that means you can't afford it. Move on and downsize your expectations.

Posted by: lechacal at April 3, 2009 1:41 PM

Thanks Dave. Except maybe advice relating to yellow snow or land wars in Russia in the winter.

Posted by: lechacal at April 3, 2009 1:50 PM

FatLenny: Ability to afford a 30-year mortgage is a minimum. It means you can actually afford the place. If you can do it with a 15 or a 5, or better yet with no mortgage at all, then by all means do so. But don't think you can afford a place just because you can afford the initial payments of an ARM of whatever stripe (option, IO, plan old ARM, or whatever). You completely missed the basic point I was making.

You seem to have gotten yourself bent out of shape about something I said somewhere else and keep sniping at me, which I guess is fine because you aren't really hitting the mark, but it is vaguely annoying.

Posted by: lechacal at April 3, 2009 3:51 PM

FatLenny: OK.

Posted by: lechacal at April 3, 2009 5:39 PM

Let me clarify my views. I am not suggesting that everyone should finance their home purchases with a 30-year fixed rate mortgage. Also, not all ARMs are made alike, and there are some that are reasonably close to a 30-year fixed on the fiscal responsibility scale (like the 10/1 that FatLenny cites). However, my basic point stands: that under most circumstances one should not judge the affordability of a mortgage payment based on early period payments on an adjustable instrument.

A 10/1 amortizing ARM is very different from, and a lot safer than, a lot of the other products out there. This entire discussion could just have easily have focused on interest-only products, and frankly probably should have. I think IO mortgages (and I'm not even getting into option products and other completely toxic instruments) are more dangerous than ARMs, ignoring of course that the two often go together.

But let's not get too hung up on the argument that a few ARM products aren't really that dangerous, which I will concede. The point is that the affordability of any product whose payments can increase meaningfully within the time period that someone is expected to own the home (or could be locked into the home in a down market) should not be judged by the amount of the initial payments. It should be judged by a sober assessment of what the payments might be under an adverse interest rate environment. There are a lot of people who never did this analysis on instruments that will reset in the coming years, and a lot of them will lose their shirts.

A very shorthand way of saying all of this is to say that if you can't afford a 30-year fixed rate mortgage you can't afford the home. Everyone got way to caught up in thinking that I was saying all mortgages should be 30-year fixed.

Posted by: lechacal at April 3, 2009 7:27 PM

Sure Danny, until you get caught underwater in a down market, your ARM resets, and you get your face ripped off. There are real risks associated with these things.

Posted by: lechacal at April 4, 2009 9:40 AM

bklnbaby: I seriously doubt you are ever going to see livable (ie, not in need of serious and expensive reno) brownstones in any of the best brooklyn neighborhoods ever trade for under $1 million again. You might find a busted up brownstone for under a million someday that you need to drop a ton of money into, but the price tag on that includes reno and therefore isn't actually under a million.

You will see a lot of condos and coops that would have sold for well over a million at the top of the bubble trading for well under a million. You might see some brownstones that would have traded for $2.5 million at the top of the bubble trading for $2 million or maybe in the high $1s (or mid $1s if things really fall apart). You will see the low-quality vinyl-sided rowhouses in places like South Slope and west of 5th Ave in the slope trading regularly for under a million (the fact that any of those places ever traded for over a million mystifies me). But if your goal is to buy a brownstone in good condition in one of the best neighborhoods in Brooklyn for under a million I think you are going to have a very long search indeed.

So to answer your question: no, there are no such deals right now, and no, you should not wait. You should adjust your expectations and start looking in Bed Stuy or PLG or Kensington or similar neighborhoods.

Posted by: lechacal at April 5, 2009 8:08 AM