Could Government Default Send Homebuyers Racing to ARMs?


B5JD2X A magnifying glass highlights fixed interest rate and adjustable interest rate mortgage loans as part of a real estate co
Alamy


By Andrea Murad

It's impossible to predict the economic consequences of a debt-ceiling breach or government default, since it's never happened (on purpose) before, but experts say one thing is certain: Treasury rates will rise. And that means mortgage rates will follow.

"Anytime there is a default, the borrower is going to get punished in terms of higher interest rate, and so if the government defaults, that means Treasury rates will also rise and that also pushes up mortgage rates. The housing market is highly sensitive to changes in interest rates," says Lawrence Yun, chief economist for the National Association of Realtors.

During the first week of October, the yield on four-week Treasury bills rose from around 0.12 percent to 0.36 percent as the yield spread between the interbank overnight lending rate. or LIBOR, and the four-week Treasury bill went negative for the first time since 2001. The average rate for a 30-year fixed mortgage inched up to 4.23 percent from 4.22 percent, Freddie Mac reported last week, the first increase in five weeks.

Hitting the debt ceiling would reduce demand for U.S. Treasuries, which would lower prices and increase rates. Anthony Hsieh, founder and CEO of online mortgage lender loanDepot, expects home-loan rates to skyrocket by a full percentage point or more overnight if the debt-ceiling is hit, a move he worries would cause people to jump into adjustable rate mortgages, or ARMs.
"In the last three years or so, consumers have been spoiled with rates in the high threes to the mid-to-low fours. If we climb into the 5 percent interest rate range, that will create psychological barriers and adjustable rate mortgages will become attractive -- even if they aren't."
He says that as political and financial uncertainty continues to swirl, now might be the time to lock in interest rates. He suggests moving from a one-year ARM to five-year, seven-year or longer, or a 15- or 30-year fixed-rate mortgage.

ARMs, of course, aren't for everyone, carrying interest rates that change according to a specific benchmark. "What we have seen in the past is consumers with these mortgages are not financially prepared for a rise in interest rates, so if they start with an introductory teaser rate in the 2.5 percent range and then it increases to the 5 percent, 6 percent or 7 percent range in the next three years, that can more than double the initial payment, and they won't be able to afford their home," says Hsieh.

Adjustable rate mortgages were one of the leading inflators of the most recent housing bubble that came crashing down in 2008 when people stopped being able to afford their monthly payments and then defaulted on their loans. It took more than four years for the housing market to regain its footing, and while adjustable rate mortgages are still in play in today's housing market, Yun isn't worried we're going to end up right back where we started.

"They are around, but it's not a resurgence. People who are taking out these mortgage are qualified individuals with high credit scores and it tends to be over a two- to five-year time period. This isn't like back in 2006 when credit scores weren't checked and loans were blindly being made"
Jed Kolko, chief economist and vice president of analytics at real estate website Trulia, says the insecurity in the marketplace will also keep borrowers away from ARMs.

"There's so much uncertainty in the political and financial arenas and an ARM, by definition, brings uncertainty since you won't know your payments. The only way they are going to take off again and become appealing is if there is more certainty."

More from FOX Business:
How Pimco Made a Killing on the Fed's Action
Federal Housing Administration to Tap $1.7B in Taxpayer Funds
How to Improve Your Chances of Securing a Mortgage

More on AOL Real Estate:
Find out how to calculate mortgage payments.
Find
homes for sale in your area.
Find
foreclosures in your area.

Find homes for rent.

Follow us on Twitter at @AOLRealEstate or connect with AOL Real Estate on Facebook.

Renter's Rules

Whether you're a new renter or previous homeowner looking to rent again, navigating the process of finding an apartment can be difficult. We're here to give you everything you need to know about renting and make your search for an apartment a little easier.
AOL RealEstate on Facebook