It seemed like a good idea at the time. Sign on for an adjustable rate mortgage and get more house for less of a monthly payment. Heck, you weren’t planning on staying in the place for long anyway. By the time the initial 4.25 percent loan hit 6.25 percent, you’d be history.
Seems you forgot something: What happens when a hot real estate market cools? The obvious answer is a bunch of houses with For Sale signs out front that aren’t drawing all that many interested buyers. But if you’ve taken out an adjustable rate mortgage (ARM) and your home isn’t moving, you’re also looking at a mortgage payment that’s a lot more than it used to be.
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ARMS used to be mostly taken out by folks who knew they weren’t in a house for the long haul. Then home prices exploded and ARMs became a vehicle for homebuyers to get more for less. Nobody expected that when the enticingly low initial interest rate changed, which it does periodically based on a predetermined economic index, they’d be in the precarious position of struggling to pay mortgages that often exceed the value of their homes.
ARMs “are inherently more risky than fixed-rate mortgages,” says Daniel Rothamel, a Realtor with Strong Team Realtors. “The key for borrowers is to manage the added risk. They need to stay on top of their ARM and know exactly when the rate is going to be adjusted, and how much the rate could go up. Usually, there is some sort of cap on the adjustment, but you need to know what it is and when it occurs in order to plan for the adjustment.”
If you can’t afford the new mortgage payment, Rothamel says you may wind up refinancing the loan. “Because so many loans are sold to investors in the secondary market, lenders have an interest in keeping you in the mortgage. As a result, your lender will probably give you plenty of options to refinance.”
Some markets around the U.S. have seen big jumps in their foreclosure rates over the last year; Nevada, for instance, saw three times as many foreclosures in March 2007 as it did one year earlier. Still, Rothamel doesn’t expect to see a significant jump in local foreclosures due to ARMS. “Right now, interest rates are still historically low, so rate adjustments won’t be as drastic as people may have feared.” And even if the foreclosure rate were to increase “as a result of unsuccessful ARMs, it probably wouldn’t be enough to have a significant impact on the overall market.”
The bottom line is that before making a mortgage decision, it’s up to you to know what’s going on in the real estate market. Ask questions and become familiar with the risks involved. And don’t talk to only one lender or consider only one mortgage option, says Rothamel.
“Arming yourself with knowledge will enable you to make an informed decision, which is usually the best decision,” he says. “Your mortgage is probably your biggest source of debt, so you owe it to yourself to be as informed as possible before making a decision.”