Terrible Feature Of The Housing Bubble Makes A Comeback

If you missed out on the housing bubble and the chance to gamble away your financial future, fear not: Banks are giving you a chance to get in on that kind of money-destroying action again.

Remember adjustable-rate mortgages, which helped pump up the U.S. housing bubble that led to the financial crisis? Well, those things are back, The Wall Street Journal reported on Monday.

To help juice their profits, banks have recently been writing many more ARMs and their slightly more-evil cousins, interest-only ARMS -- which allow borrowers to pay only interest for a certain period, leading to more debt and higher payments in the future -- according to the WSJ.

"The tactics are reminiscent of the period before the 2008 crisis, when ARMs exploded in popularity as banks and mortgage brokers touted their low initial rates to consumers," wrote AnnaMaria Andriotis and Shayndi Raice.

Not to worry: Banks say they are totally being careful this time, giving ARMs mainly to high-income borrowers with good credit. ARMS make up only about 10 percent of mortgages under $417,000 -- the dividing line between regular and "jumbo" mortgages. At the peak of the bubble, roughly half of these mortgages were risky ARMs.

But ARMs make up about a third of all mortgages between $417,000 and $1 million, the highest percentage since before the recession, according to WSJ data. And they make up about 60 percent of all mortgages above $1 million.

So this is maybe not putting the housing market in jeopardy. Yet. But this could still be a terrible deal for homeowners down the line.

Mortgage rates have jumped a bit lately, to about 4.3 percent for a 30-year fixed-rate mortgage, up from a record low of about 3.4 percent last April. As you can see from the chart below, though, rates are still near their lowest levels in history. Why would you not lock that down?

One reason not to lock such low rates down is that an ARM typically means lower payments in the short term. After that, you will be gambling that the United States is basically going to be Japan for the next decade or so, with rock-bottom interest rates lasting forever.

That's not the world's worst bet. It's possible. But the risk is that you'll find yourself in five years with an interest rate that could be much higher than your initial rate. And if you've got an interest-only ARM, you'll be paying that rate on principal that has been largely undented.

As the WSJ pointed out, when writing ARMs, banks are betting that interest rates are going to rise. That is the opposite of the bet you'd be making if you took out an ARM. Some homeowners might be gambling that they can sell their house or otherwise get out of their mortgage if their interest-rate bet goes wrong. But as we learned when the housing bubble popped, selling a house is not always such an easy thing. It'll be even harder when interest rates are rising.

As history has shown us, when banks bet against homeowners, the banks usually win.