Secret #44 – Lower-Only Adjustable-Rate Mortgages (LO-ARMs) Would Stabilize Home Ownership and the Economy

The basic idea has been pitched in the past but the establishment avoided talking about it. It’s essentially an adjustable-rate mortgage (ARM) where the interest rate can only adjust down, not up. See also the “ratchet mortgage” idea here.

When interest rates fall, your Lower-Only ARM (LO-ARM) mortgage payment automatically falls but when interest rates rise, your mortgage payment doesn’t. It’s like automatic free refinancing whenever rates fall without the risk of having to pay more per month when interest rates rise like with regular ARMs.

Normal ARMs charge a lower interest rate than fixed-rate mortgages. These Lower-Only ARMs would charge a higher interest rate than fixed-rate mortgages but would increase the financial stability of home owners with these mortgages and of the U.S. economy in general. 

No Negative Equity Trap. When house prices and interest rates both fall a lot, like during the Great Recession, home owners would not be caught with mortgages they could NOT refinance because the value of their houses had fallen too much. We’d have far fewer foreclosures when both house prices and interest rates fall so house prices would fall less. In the 2000s, prices would have fallen a lot less if Lower-Only ARM mortgages had been common.

Automatic Macroeconomic Stabilizer. In addition, the change would be a boon for economic stability. When the Fed lowers interest rates it would have a much quicker and larger impact on the economy.  There would NOT be such a long lag from the time the Fed cuts rates to the time some home owners refinance their fixed-rate mortgages. U.S. recessions would be shorter and shallower.

Less Household Debt. Lower-Only ARMs would also lower mortgage debt nationally. When they refinance, many home owners take out cash, or get a new 30-year mortgage adding years of mortgage payments, or both. With Lower-Only ARMs that wouldn’t happen. Their mortgage payment is automatically lowered when rates fall without adding years of mortgage payments so U.S. mortgage debt would fall faster over time which would also add to macroeconomic stability, and shallower and shorter recessions.

Yes, interest rates would be higher at first but once interest rates fall enough to cover the additional cost, all future rate declines would be passed through to home buyers. If we had converted to LO-ARM mortgages in the 1980s, mortgage rates wouldn’t have fallen at first but after that LO-ARM mortgage rates would have fallen for the next 30 years and the Great Recession wouldn’t have been “Great.”

Perhaps instead of using the typical first-home buyer tax credit program to help lower-income, first-home buyers, we could create safer mortgages and mortgages that don’t drive up house prices like the tax credit programs do. It won’t increase home sales in the short run but it would increase home ownership and household financial stability in the medium and long run.

What if the Fed only bought mortgage-backed securities backed by LO-ARM mortgages? That would lower LO-ARM rates, increase the number of those mortgages, and that would help stabilize the economy and help the Fed meet its mandates.