How co-op boards view ARMs

Getting some slightly scary warnings from people about which mortgage to choose with respect to a co-op board's decision on me. some background- this is a large building, the apartment is <400k, and I am well-qualified with respect to finances IMO. Now, I plan on being in this property for approximately 5 years. I know 'anything can happen', etc etc but I certainly think its fair to at least make the assumption. The difference in rates I can obtain is significant when looking at a 7/1 or 10/1 ARM versus a 30y fixed. Knowing that I will not be in the apartment at the time the rate will likely rise, I am really not making a risky financial decision or thinking I can outsmart the market- I simply will save a substantial amount of money over the time I am in the unit with an ARM. To me it is a sound, defensible decision. But do many boards view short term ARMs as risky, or revealing something unstable about the prospective buyer? Is it basically also a signal that I do not intend to be a long-term owner/resident in their building? Should I attempt to hide this fact? I wouldn't think so, but would like some educated thoughts..

Thanks.

Something didn't get typed correctly in your post. The way they view an arm depends upon the terms, of course, and all the other factors that usually get considered. If you may have to be paying substantially more on your mortgage in 5 or 7 years, then the board will want to see that you will still be able to afford the apartment. If your finances are such that with current terms of arm you are just going to get by in terms of meeting board requirements, then obviously it will be a problem. Boards look for no more than x% of your income go to supporting the apartment. If the only way you make that percentage is by taking out an ARM, that isn't good. On the other hand, if you could easily afford a 30 yr mortgage and also could adapt to an ARM that goes up to 10% or whatever it can go up to, then there shouldn't be a problem.

Is there something in particular you have a question about in terms of your situation?

The mortgage type ought not to be judged in isolation from your overall financial standing.

However, If you must have an ARM to afford this place, if you're cutting it close, I would say you definitely could be in trouble--even though I don't know the building and of course that's the most important thing.

If you have substantial liquid reserves (at least 2 years of monthly payment money in savings; retirement funds do not count), a solid job, a solid work history, an appropriate net worth relative to this apartment--unless this is a quirky or a stiff board I don't see why you would have any problems just because you want to choose an adjustable rate mortgage product.

However, interest rates are low and I don't know why you would chose an ARM at this time, unless you plan to flip it...or unless you are indeed stretching too far. Either of those could get you into board trouble. The ARM's not the problem, your finances are.

And I hope the scary warnings are not coming from the listing broker! If so then the listing broker is almost certainly correct.

{Manhattan real estate agent.}

All good points made by Fluter. And most true: why on earth are you getting an ARM? Interest rates have nowhere to go but up right now and when it comes time to refinance you will surely be faced with less favorable terms--potentially MUCH less favorable terms.

yeah, I have no idea what is going on with that initial post. a mess. sorry.

I intend to be in the apartment for about 5 years. While I am aware of the inherent risks of an ARM increasing to say 10% after 10 years, I will save a fair amount of money over the period of time i intend to live in the building with an ARM vs a fixed. my finances are stable and could easily cover a 30y mortgage, but it seems foolish to simply throw away that savings. my (eaten by the interwebs) question is sort of two parts- one, should i cover up the fact that i fully plan on being in this building for less than ten years? and two, does getting the 10/1 ARM open the possibility that the board will consider me risky, stupid, blatantly short-term, or all of the above? hoping that when i hit reply this all comes through. thanks.

There are only three justifiable reasons to get an ARM:

1) you think your income will go up over the fixed term, so it helps you "stretch" to buy an apartment you'll grow into nicely;
2) your income is variable or high, and you plan to pay down a chunk of the principal at the lower teaser rate, so you're getting cheaper money;
3) you're going to dump the apartment before the teaser ends.

For purposes of a co-op board, your story is #2.

I wouldn't address the issue unless asked -- simply present your finances. Fluter noted that two years of payments in reserve helps, but that's a lot, and not everybody can do it.

If you are "marginal" I would present other financial factors. For example, retirement funds "don't count" towards the ratios the board is looking for you to hit, but showing that you have substantial money in retirement funds shows a pattern of savings, which means you have good financial character.

ali r.
{downtown broker, with two 5/1s}

sorry, I forgot 4) you're betting that rates drop over the teaser period. Shows you what a bias we have that the current assumption is that rates are headed up.

ali

ali, thanks for the quick reply. basically, my reason for the ARM is simple- its frakking cheaper, by a lot, and i do not intend to be around for 10 years, so the inevitable skyrocket in rate will not harm me. how does one justify this decision to a board when they have your financials, salary info, etc and you cant really tell them much of a story about your 2) above? again, unless i know very little of how boards view candidates (certainly possible) i am not marginal. this unit was a sound and well within my means decision IMO. i could easily afford the 30year. now, do i have 2 years of mortgage payments in non-retirement accounts? no. so who knows.

buti just am not sure how to get around the issue of shortish-term occupancy when explaining the ARM decision.

You do have at least 1 year's worth of payments sitting in savings, right?

Most co-ops will make you have that.

Otherwise, just tell the board the truth--you've saving a ton of money with the ARM. And if you're smart, since you can afford a 30 year mortgage, you'll do what front porch says and pay down the principal with the difference you save.

Re: short term occupancy. Not to worry. I regularly meet people who planned to sell in 5 years and who still own the place more than 10 years later. You don't actually know what you're going to do 7 or 8 or 9 years from now.....or even 1 year from now. If life throws you a curve ball, you'll find out how little control you really have.

And that's another reason to pay down that principal, if you can. The only exception would be if you have access to a higher yielding investment that is also as safe as paying down your apartment's principal.

{Manhattan real estate agent.}

"one, should i cover up the fact that i fully plan on being in this building for less than ten years? and two, does getting the 10/1 ARM open the possibility that the board will consider me risky, stupid, blatantly short-term, or all of the above? "

As a board member, I feel I can answer this with a degree of authority.

Question #1. No.

Question #2: Yes. We are looking at your entire financial picture, and if you can't afford the future "reset" rate TODAY -- unless you can prove in writing that your income WILL go up enough so that your monthly carrying costs won't exceed 30% of your total income -- we will reject you.

Off topic: I am not an extremist on this board and think I've established myself as pretty middle-of-the-road on the issues. Here, I must say, that to buy in this market, at this point in the US economy, and have only a 5 year time horizon is almost insane. Odds are quite good that you could find yourself underwater with such a short time horizon--especially when you factor in transaction costs.

Have you seriously looked at this and figured out why it makes sense for you not to rent? With a 5 yr horizon, frankly, I'd rather rent anything at even a slightly higher price point than I might otherwise consider. And mind you, this is coming from someone who bought a place in '08. There are buyer profiles for whom buying makes sense--even in the last 2 years. But are you sure you are match one of them?

Why get an ARM? Because you can currently get up to a million-dollar coop mortgage at 4.875% on a 10-year ARM, that's why. But I agree with the other posters that you shouldn't get one if you have to stretch. If you're planning on prepaying pretty agressively, it can make a lot of sense.

I think if you can save 50 basis points in interest for 5 years, and save up a lot of cash during those five years, and earn a better after-tax return on the cash you save than the interest rate on the loan, then wouldn't an ARM be worth it? You may be able to prepay such a large portion of the mortgage at the 5-year point that the short-term savings would overwhelm the cost of having a higher rate in years 6 through 30.

ARMs are great, for the right person. I am paying a fully-indexed rate of 3.25% right now and loving it.

Use ARMs to save money, NOT to stretch what you can afford.

My experience over the last 15 years with mortgages is that ARMs have saved me a ton of interest.

The problem is, most people are using ARMs to stretch into homes they couldn't otherwise afford with traditional fixed-rate mortgages. Thank God with co-ops, there's at least ONE parent in the room ...

ok stupid....mr vp of nothing....

would you rather see a 10/1 ARM with a LTV of 50% or a 30 year fixed rate with a LTV of 75%?

in 25 years of buying real estate, i've never had a fixed rate mortgage.

OK, here's -- not the bull case, but the anti-bear case.

You know how many foreclosures there were in Manhattan last month?

Fifty-two.

If the apocalypse is coming, it's taking its time.

Believe me, *I know* that the economy in 2009 sucked. One of my industries (publishing) is in the middle of huge sea change, and my income from it has been sliced maybe 40 percent, and we're in a new world where things will NEVER be the same. My other industry (real estate) is in the middle of a cyclical decline not seen for more than a decade.

And yet this year hubby and I bought, and we bought using a 5/1 ARM. The combination of current pricing down about 25% from peak, our underlying need to move, and cheap money was too good to resist.

I'm with the consensus that 2010 is going to be another miserable year for New York City. It looks like we've got another 200,000 or so jobs to go, and interest rates will probably start rising by the end of the year.

But this whole bear idea that nobody with a five-year time horizon, especially with a ten-year teaser rate, should buy -- I just feel like it's WAY overstating the downside risks at this point. A year ago, my colleague 30_yrs laid out the scenario for me that would replay the 90s crash, with foreclosures everywhere you look. I disagreed then, and I disagree now. It may be too early to call, but I still haven't seen it.

And KW, I'm surprised you're even making the argument. I agree transaction costs are not inconsequential, but OP is a co-op buyer, which means he/she is going to put at least 20 percent down.

So what's his/her downside risk?
* Job loss, which OP feels he/she has gauged, and feels is unlikely;
* additional price deceleration of more than 20 percent over the next few years, which is more than most real estate experts (I'm thinking Zandi/Roubini/Miller here) are predicting;
* interest rate risk, which the OP is protected from ten years.

On the upside, there's the mortgage interest tax deduction, the idea that owning a co-op provides a nicer and more customizable living space than comparable rentals, and the possibility that prices stay flat for the next five years (my forecast), or even recover a little.

I'm not saying EVERYONE should buy, by any stretch, but I don't think it's wacky for the OP (who is not a client of mine) to jump in.

ali r.
{downtown broker}

op here. thanks again for all of the insightful replies. to be clear, again, i am not even close to stretching what i can afford with this ARM, or with the apartment in general. it is a modest starter apartment. the rent/buy dilemma is obviously one with no easy answers, and i am prepared for the eventuality that my decision wasn't the most optimal. however, knowing that even in the worst case i will remain within my means to pay the adjusted high rate, i feel the savings (>10k) over that time period is worth it. and that any explanation sought by the board should elicit an honest answer: no, i don't know what the l-t future holds, but i do know that the s-t future holds more money in my higher yield accounts and could also be used to prepay quicker if by some happenstance i needed to stay forever. make sense?

Ali, as always you share reasoned opinions. When it comes to home ownership, because of the amount of money involved and potential to impact one's financial health and quality of life well into the future, I'm extremely conservative. The OP here seems to have thought this all through. That is clear now. But for me, a 5-year horizon means a substantial risk of no rise in property value or not enough to clear the transaction costs of buying and selling. By training I can't help but think in terms of worst case scenarios and planning for how to navigate them safely and successfully. As a result, personally, I would rather rent for 5 years than own for just 5 years right now. And as you know from my past posts, I HATE renting. Others who are perfectly sentient rational beings may disagree, but I wouldn't have the stomach to buy right now without a 10 year + time horizon. If I had a short horizon (5 yrs is short), I would have been happy enough in a great prewar rental on lower 5th Ave for 5 years. Granted, it wouldn't have been the customized "perfect" home I was able to create out of an estate condition coop I bought nearby, but so be it. I know me, and with only a 5 year horizion I'd have been a nervous wreck about the economy and RE market during that short 5 yrs and that would have countered any benefit I got out of owning versus renting for those years. Guess the lesson is know thyself. Risk tolerance varies. Mine is fairly low.

"You know how many foreclosures there were in Manhattan last month?

Fifty-two."

Ali,
I'm curious where you got this number from. It sounds like the number of foreclosure auctions scheduled, or perhaps includes uncontested "owner gave the keys to the bank" transactions. I say this because I didn't see anywhere near 52 completed foreclosure sales last month. But then again I don't follow the sales of whole buildings North of 96th St much, so if a lot of them were in that category I easily could be seeing skewed results.

_________________________

David Goldsmith
DG Neary Realty Ltd.

whow...thought you went off in a huff. stay there. huff is good. if you're gonna threaten to go away, you gotta stay away.

cc-speak for yourself - 30yrs posts are usually really informative, unlike yours, which are usually just- what -self-aggrandizing potshots?

kw, you're a doll as always.

30_years, you know no one really tracks foreclosures, right? The best data we have is from RealtyTrac, which I believe throws some general defaults and lis pendens into their number. Still, it's what everyone uses. My point was that it's incredibly LOW, and your point that all of those aren't even real foreclosures helps.

Got your email yesterday. Not coming into the office today: I have an inspection at 23rd Street noonish, and other than that I'm baking with my bluetooth on -- call me.

ali

font_porch: "And KW, I'm surprised you're even making the argument. I agree transaction costs are not inconsequential, but OP is a co-op buyer, which means he/she is going to put at least 20 percent down."

You've lost me here. How does a significant down payment protect against loss?

In this town with relatively high price/rent ratios, substantial maintenance costs of ownership, and 8-10% transactions costs, a flat market is a killer

walter, flat incomes are killers, not flat markets. One wouldn't mind selling flat to buy flat, paying transaction costs along the way, if one could get more housing after several years because one's income rose.

In fact, that's how we thought of housing for decades in this country -- one went from a starter house to a larger house not because housing prices went down (in fact, they consistently went up a little), but because generally, one's income rose.

It's really just the past couple of decades where that hasn't been true. But in general, homebuyers with "short" time horizons (and in a nation where Americans move an average of every seven years, I'd call five years short) still have that expectation.

ali r.
{downtown broker}

Walter: Significant downpayments protect against loss by discouraging buyers from over-paying.

Post87...LOL. Ali, flat incomes, without the aid of 'high octane' lending, will lead to flat markets. The financial engineering, with the incouragement of the U.S. government, lead to flat incomes and rising markets. That is reversing.

I still don't understand how 20% equity protects against loss with a 5 year time horizon (which was the original discussion).

"I still don't understand how 20% equity protects against loss with a 5 year time horizon (which was the original discussion)."

OK, I'll spell it out for you.

You put 10% down on a $400,000 apartment ($40,000). Your financials at this point are great -- you're earning $240,000/year.

Then you lose your job. You're unemployed for nearly a year. Your savings is running out, and at $405/week, unemployment barely pays for food and electricity, let alone your $2100 mortgage payment and $900 monthly maintenance.

You have one more month before the money runs out -- you are now down to the last $5,000 to your name. Your credit cards are maxed out, and shut off. WIth no job on the horizon, you have to get out of this apartment. What do you do? Put it on the market. But in this depressed market -- the very same market that threw you out of work -- the value of your apartment has slipped by 15%. In a best-case scenario, you'll get an offer for $340,000. But your mortgage is still close to $360,000.

Here are your options:

-- Accept the offer, and bring $20,000 to the table to complete the sale. (Might as well be $200,000, when all you have left is $5,000.)

-- Ask the bank to accept a short-sale, in effect "forgiving" your $20,000 shortfall.

-- Sit back and let the bank foreclose.

THIS is where the "risk" to the bank comes in when you have less than 20% equity in your home.

Matt: Walterh is saying that 20% equity isn't enough, in the same way that you're saying 10% isn't enough.

Oh sorry. I thought he meant he didn't understand why you needed any equity.

Well that's not what I meant, but it occurs to me that maybe I didn't really understand what Ali was writing. I'm not looking at my apartment as a savings/wealth building vehicle. All I'm asking is how having a larger down payment into the apartment protects the owner from losing money in a flat market after considering transaction costs. I don't understand the relationship between losing money and increased equity (and perhaps that is not what Ali was saying in the first place).

More equity -> less chance of 'forced' sale, thru the magic of lower monthlies. Buy you are correct, a loss is a loss irregardless of capital structure. Ali is a borker, tax credit is grt bc it makes me more money, kinda person.

""All I'm asking is how having a larger down payment into the apartment protects the owner from losing money in a flat market after considering transaction costs."

It helps prevent a foreclosure if the owner loses his job.

walter: I think I know what you are asking and if I'm guessing right: you are correct: increasing the size of your down payment does not lessen your risk of loss of $ or equity (unless it's total loss of equity because you "run out" when you wouldn't have if you had put down more). Actually, to some extent at this point in time it is the other way around: if you put down less of a down payment and are forced to sell when under water, AND are able to work out a short sale with the bank, you actually lost LESS $/equity because the bank took the hit instead of you. Of course, I can't say I recommend that as an entry strategy on the buy end (unless you are "too big to fail" and know Obama will bail your ass out no matter how bad/overly risky decisions you make).

so...obama is the devil? what would you have done differently?

Not hired only economic advisers from Wall Street firms who recommended handing huge amount of money and other aid to their preferred industry (OTOH, please recognize that it was at least little tongue in cheek).

whoa....tarp predated the obama administration; you do acknowledge that fact, don't you?

and while i have my own issues with geithner and summers, to characterize them as being from wall street firms is completely inaccurate.

columbiacounty
about 11 months ago
stop ignoring this person
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whow...thought you went off in a huff. stay there. huff is good. if you're gonna threaten to go away, you gotta stay away.