Friday, October 01, 2010

Unintended Consequences Strikes Again

This is just rich. A mortgage provider, ING Direct, gets into trouble for promoting ridiculously low adjustable rate mortgage, but the rates quoted were the result of federal rules.
The ING Direct loan is called a 5/1 Orange Mortgage, and as of early September, it came with a 3.25 percent interest rate for the first five years and a projected interest rate of 3.375 percent for the 25 years after that.

Yes, you read that right, under 3.5 percent for the next 30 years.

But that is not right, in any number of ways. First of all, by not using the words “adjustable rate mortgage” or similar terms to describe the loan, ING Direct violated a simple Federal Reserve disclosure rule that was revised in 2008.

And that “projected” interest rate suggesting that today’s record low rates will continue for a generation? It is utter nonsense. But ING Direct seems to have had no choice but to use the numbers that it did, because of another relatively new Federal Reserve rule.
It all sort of makes you wonder: have we accomplished anything over the last several years?
No. We haven't learned anything because the politicians who demand these changes don't understand the markets involved or how one change can have unpredictable and unintended consequences.

No one knows what the rates will be in a five years - when the initial teaser rate ends. Yet, the ads make it seem like a no-brainer to obtain a mortgage that has tremendous risk - affordable introductory loan rates, but which can increase tremendously at the end of the period.

It's a problem that contributed to the real estate market crash when subprime mortgages - many of which were adjustable rate mortgages - defaulted.

So how does the new regulation create problems?:
Regulation Z requires companies to make a projection and insists that they use current figures to do so. Why use today’s numbers? Well, nobody knows what the rates will be in five or seven years when the interest rate resets on loans like those offered by ING Direct. This rule was changed after some lenders offered teaser rates — say, 1 percent for only a month or so. The Fed’s idea was to give borrowers a sense of the rate they might face.
No one knows what the rate will be, but it isn't likely going to be as low as they are now. A far more accurate ad would be a statement to the effect that the rate is variable and could potentially be far higher than today's current rate for the introductory period.

Instead, we get a lender complying with the regulation peddling a rate that will be quite a bit different - and potentially quite a bit higher.

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