No Real Surprise to the Informed

Critics of ARMs call this huge jump payment shock. But this supposed shock resulted because the naive borrower didn't read the details of this loan. In fact, in the first edition of this book (2003), I wrote, "given the extremely low yields on short-term maturities during 2002, you should not be surprised to see this index move up to at least 3 or 4 percent during the next several years." And that's what happened. This same index today sits at around 5.0 percent.

With a 2002 inflation rate of, say, 2.0 to 2.5 percent, indexes then based on short-term yields such as the one-year Treasury showed negative real rates of return (see Secret #32). Short-term rates were unusually low in 2002 because the Federal Reserve Board slashed interest rates to stimulate the economy. During 2002, mortgage borrowers (especially short-term borrowers) loved these ARMs tied to short-term yields. At that time, the steep yield curve made ARMs the low-cost choice for savvy borrowers who knew how to play the mortgage game.

8 All figures are approximate due to rounding.

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