Photo Credit:Iman Mosaad
Automatically adjusting loans in the future?
Adjustable-rate mortgages (ARMs) get much flack for being, well, adjustable. The idea of monthly housing costs rising after months or years of having an ARM, doesn’t sit well with many in the post Great Recession era. Researchers at Columbia Business School, Fannie Mae and University of Chicago, say borrowers with ARMs saved an average of $150 per month when interest rates dropped. This not only leads to improvements to borrowers’ bottom lines, but there’s less credit card debt, borrowers are more likely to purchase big-ticket items such as cars and their communities may see an increase in jobs.
The researchers, in a working paper for the National Bureau of Economic Research, said that the Federal Reserve policy which lowered mortgage rates many years ago, helped stimulate consumer spending and crank up the economy. This was in line with what the Fed hoped. Conclusions came after tracking the payment history on 400,000 ARMs and other types of debts owed by the borrowers who took out ARMs. The mortgages had a fixed rate for five years and then adjusted each year afterward. All ARMs were closed between January 2003 and July 2007 and they started adjusting by the time interest rates hit historic lows because of the Fed’s policy.
Deep into the 2008 financial crisis, the Fed started buying a big amount of Treasury bonds and mortgage-backed securities, which led to decreases in interest rates. After the Fed bought more, rates fell even more. This study’s conclusion explain why borrowers whose rates adjusted, saw their monthly housing costs decline. Default rates fell 40 percent in this group, compared to another group of home-owners with similar characteristics whose loans did not adjust.
After interest rates fell and ARM borrowers had extra money, they felt more confident buying a car. Also the consumers with the high credit card balances, used more than 70 percent of the extra money to pay down those debts in the first year after their interest rates were reset. Doing this made more sense because the average interest rate on a credit card was about five times higher than that of a mortgage during this time. The study shows that not only does this credit card pay down help credit card issuers, but it helps consumers improve their credit standing.
Thomas Piskorski, one of the study’s authors and an associate professor at Columbia Business School, said the policy change did not generate much consumer spending among those affected borrowers. “That’s one impediment of this policy. If the goal is to stimulate household spending, policy makers might consider tackling the cost of the credit card debt”, Piskorski said.
Piskorski favors having mortgages automatically reset across the board when interest rates fall. In this scenario, the borrower doesn’t have to do anything and they’ll still get the benefits even if they have low credit scores or little equity in their homes. Janice Eberly of Northwestern University, a former Treasury Department official and Arvind Krishnamurthy of Stanford University, put forth a similar idea in a recent paper. They suggested that mortgages could be designed to automatically refinance to a lower rate when there’s an economic crisis. The goal is to eliminate the possibility for the borrower to foreclose and to help increase consumer spending.
In the paper, the authors posited that temporarily reducing interest rates for borrowers headed to default, is a more efficient use of government resources than forgiving a portion of the mortgage debt. This gives the same effect, but at a fraction of the cost because of its temporary nature, rather than the permanence of debt-forgiveness. Amir Sufi of the University of Chicago and Atif Mian of Princeton University, disagree; they believe that reducing troubled borrowers’ mortgage debt during the crisis years, would have had a big impact.
The study also looked at home prices and mortgage data by ZIP Code. Areas with high concentrations of ARMs and areas with high amounts of fixed-rate mortgages were compared. The researchers found that the areas with more ARMs, experienced a faster recovery in home prices, employment and car purchases after the lower interest rates were effective. When rates adjusted, borrowers simply paid less on their mortgages, this in turn spurred more spending in local economies and more hiring in their regional grocery stores and restaurants as a result.
The researchers, which includes Benjamin J. Keys and Amit Seru of the University of Chicago and Vincent Yao of Fannie Mae, said although the Fed’s lower interest rate policies had limits, household bottom lines were definitely improved.
“We don’t take a position on whether the federal policy is optimal or not,” Piskorski said. “There’s always the risk of inflation. But the policy did have a meaningful impact on the economy and you have to take that into account going forward.”
The Washington Post. How mortgage rates affect car purchases, credit card debt and jobs