Almost every person reading this probably has a personal experience with someone (or themselves) who have financed or re-financed their home with an interest only adjustable rate mortgage. What is an interest only ARM? Basically it’s a loan where you pay only the interest on a loan that will start to adjust after a certain amount of time. Typically 3-5 years after the loan is originated. What’s so risky with these loans? Well, if you don’t know by now you haven’t been reading the news. (Not that the news is always right mind you.)
But just for the uninformed let me give you a worst case scenario: Bob desperately wants that beautiful new rambler on the corner lot. Problem is he can’t afford it on his salary with a fixed rate 30-year loan even though 30-year rates are some of the lowest in history. What to do? Well Hello there Bob! Why not take out a 2.7% interest only 5 year ARM? Surely you’ll be able to refinance after your salary goes up or you’ll sell if it looks like you’ll have trouble making the payment. Right? Well, perhaps not. By the time Bob gets towards the end of his fixed rate period that he has enjoyed for almost five years the real estate market has cooled and no-one is really interested in purchasing his home. What’s more, his income hasn’t gone up enough to cover what will amount to almost a doubling of his monthly payment! All of the speculators have moved on and it’s a buyer’s market. So what does he do? He goes into foreclosure that’s what! (Keep in mind this is a worst-case scenario but still highly likely and beginning to happen in some local markets.)
For more information take some time to read the Business Week story on this issue:
Why is the surge in interest-only mortgages so frightening? Because many people are using them to buy houses that they couldn’t otherwise afford. The monthly payment on an interest-only loan is lower because there’s no amortization of principal. So people can qualify for bigger loans and buy bigger houses. The availability of such loans has probably contributed to the upward spiral in home prices, as shoppers armed with cheap financing try to outbid each other for choice properties.
A Growing Tide of Risky Mortgages
Here’s a suggestion: Go to RateState.com to get a free comparison quote for a 15-40 year fixed rate mortgage if you find yourself in Bob’s position.
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