Rapidly rising interest rates in recent months have cast a pall of uncertainty over the adjustable-rate loan market, squeezing lenders and borrowers and forcing some lenders to make the loans more expensive and less available for borrowers.
Concern is also growing that these adjustable-rate loans could eventually lead to widespread borrower defaults if monthly mortgage payments continue to balloon amid soaring interest rates. In some cases, rate increases are raising home-loan borrower costs by thousands of dollars a year.
Meanwhile, some major lenders in California, including Glendale Federal Savings and Coast Savings, have cut back on certain types of adjustable-rate home loans or laid off loan employees. To prevent any further erosion of profits, many lenders also are raising rates on ARMs and reducing the periods in which the popular, introductory "teaser" rates are in effect.
In Orange County, executives at some savings and loans said they are exercising more caution in making adjustable-rate mortgages as a result of rising interest rates.
At Delta Savings & Loan in Westminster, President Joseph Gaskill said potential borrowers are finding it harder to qualify than in the past. "We are being very cautious about our underwriting," he said. "The borrower may or may not understand what he got into, and the next thing you know, he can't make his payments."
Teaser Rate Raised
Delta is "not aggressively seeking" adjustable-rate mortgage customers, Gaskill said.
Fullerton Savings & Loan in Fullerton has increased the teaser interest rate offered during the first few months of its adjustable loans, President Carl W. Gregory said.
"Six months ago we were at 7 3/4%, and now it's at 9%," Gregory said. "We have raised our (introductory) rate because it takes about a year and half for the association to recapture its cost."
Profits for the savings and loan industry, particularly in California, are being squeezed because rates on many ARMs have not kept up with rising rates in the economy, analysts say. The squeeze caused by ARMs may only be temporary and would probably disappear if interest rates start heading down again.
Nonetheless, recent developments have shaken some widely held beliefs about the loans that were supposed to be the savior of the S&L industry. Some analysts now fear ARMs may become yet another major problem for an industry already drowning in red ink and in need of massive taxpayer assistance to solve expensive failures by hundreds of firms.
ARMs have been a fixture in the American home market only since the early to middle 1980s, but now account for a major portion of mortgage lending. Before 1983, savings and loans made mostly fixed-rate loans whose monthly payments remained constant.
ARMs were introduced as a way to protect thrifts against rapid boosts in deposit costs that sparked such heavy industry losses in 1981 and 1982 when interest rates soared into double digits. The new loans, whose interest rates could be adjusted periodically, empowered thrifts to raise the monthly mortgage payments if rising rates boosted costs.
But today's rapidly rising interest rates are posing a serious challenge to the credibility of the ARM for borrower and lender alike. Never before have ARMs been severely tested in a major way in a volatile environment of rising rates, lending experts say.
"Adjustable rate loans only work (well) within a certain range of interest rates," said R. Dan Brumbaugh, a banking consultant in San Francisco. "To the extent that rates move quickly, it exposes the lender to significant risks."
Brumbaugh said the rising rates raise questions about the credit quality of these loans, particularly if homeowners cannot keep up with the rising monthly payments. "I can assure you that thrift chief financial officers are very worried about the credit side of these loans," Brumbaugh said.
In some cases, lenders have relaxed lending standards to allow buyers to qualify for a mortgage loan, according to Paul Getman, director of financial services for WEFA Group, an economic consulting firm in suburban Philadelphia.
Lenders are supposed to require borrowers to be well-heeled enough so that the monthly mortgage payment generally does not exceed 33% of their monthly income. But some lenders, anxious to make loans, are allowing borrowers to qualify for mortgage loans even though the monthly payments will consume half their monthly income, Getman said.
These kinds of loans are much more likely to result in default if interest rates continue to rise and swell monthly mortgage payments for cash-strapped borrowers. "I consider this to be a serious problem right now," Getman said.
Another problem for thrift lenders in California is that the 11th District cost of funds index--on which a majority of ARMs in California is based--is not keeping pace with rises in interest rates in the economy. (The 11th District is a regulatory designation that includes thrifts in California, Arizona and Nevada.)