What - The adjustable rate mortgage is a form of financing that has fallen out of favor as of late. Instead of getting an interest rate that stays the same throughout the life of the loan, the ARM adjusts - or changes - periodically depending on current market conditions. It can be adjusted upwards or downwards (usually on a quarterly basis) depending upon what direction the rate the loan is based upon moves.
If you get an ARM loan and interest rates go up, your payments can increase - sometimes dramatically. By the same token, if they fall, your payments will fall. Most lenders have a clause in your contract that sets a ceiling on how far or how fast your rate can increase. If you have bad credit, your lender may have a floor interest rate built in that says your interest rate will never drop below a certain level, regardless of how low interest rates get.
When - There's a time and a season for everything, and ARMs are the same way. If you have serious credit issues that you're trying to resolve, an adjustable rate mortgage just might get you an approval when everyone else is saying "no". At the same time, if you think you may be moving soon, it might make sense as well.
Who - The best time to consider the adjustable rate mortgage is if you have a lot of uncertainty or instability in your life. For instance, if there's a strong likelihood that your company will relocate you halfway across the country in a few months and you're planning on selling your home anyway, it could make good financial sense to utilize this strategy. It could free up cash for a move. If interest rates take a huge jump in a short period of time, it isn't likely to hurt you much because your loan will be paid off with the sale of your home.
Why - An ARM has less certainty than a fixed rate loan. If you want to save money and you can handle the risk that rates might jump dramatically upward, this might be a good strategy. However, I want to caution you that there is a lot of risk in taking this approach. If you can't afford to make dramatically higher payments if rates rise or your budget relies heavily on consistency, don't get an ARM.
As you can see, the adjustable rate mortgage doesn't come without some risk. But if you know the risks - and the rewards - going in, an ARM might be a sound financial decision. The best thing you can do is to sit down with a calculator and make some best and worst case budget calculations. If you're a risk taker and you can handle it, you could save a lot of money.
The loan reset issue is not confined to those who bought late in the bubble rally of the Great Housing Bubble. Many borrowers are homeowners who refinanced to take advantage of more favorable loan terms. Most loans originated in the later stages of the bubble rally were adjustable rate mortgages. When these mortgages reset to higher payments, most borrowers defaulted, and their properties went into foreclosure.
During the Great Housing Bubble, prices rose dramatically in nearly every market nationally. With such a dramatic increase in prices, one would expect the total home equity for homeowners to increase dramatically as well. If fact, the opposite occurred; home equity declined during the rally of the real estate bubble. By the end of 2007, home equity as a percentage of home values was at record lows. Where did all the equity go? Existing homeowners spent it, and many new homeowners had such low downpayments, that they had very little equity to begin from the start.
Refinancing and home equity withdrawal is the primary reason home equity did not rise as prices increased. There was a great deal of conspicuous consumption in the bubble rally, particularly in California. It seemed every house had two luxury cars in the driveway, the malls were always full of shoppers, and every homeowner was busy competing with her neighbor to see who could look richer. Many also spent their "liberated" equity to acquire other properties which was a major driver of the prices in the bubble rally.
Aggregate home equity statistics can be misleading because approximately 30% of US households have no mortgage at all. Also, during the bubble rally, home ownership increased 5% nationwide, and many of these new homeowners were subprime borrowers who utilized 100% financing. This will have some impact on home equity statistics, but it is not sufficient to cancel out a 45% increase in home prices without massive home equity withdrawal. If the home equity statistics are viewed in the context of those households that have a mortgage, total equity nationwide was around 35% in 2006.
The initial price declines caused by defaulting subprime borrowers set the stage for defaults by Alt-A and Prime borrowers by lowering property values. At the time of this writing, the Alt-A and Prime borrowers have not yet faced the prospect of their loans resetting to higher payments as they start facing resets in 2009 that continue through 2011; however, it is not difficult to speculate on what will happen.
Both new homes and foreclosures are must-sell inventory. The presence of must-sell inventory in the market forces prices lower. Builders aggressively cut prices in many markets in 2007 and 2008, and it did not help sales. The builders will be forced to lower prices more in 2009 and beyond until prices bottom in the new home market. Foreclosures increased dramatically in all markets in 2007 as the pressure of large debt loads overwhelmed many borrowers. The number of new units and foreclosures is not a problem in a healthy market, but in a declining market with large numbers of REOs, this must-sell inventory drives prices lower.
The lowered property values will make it difficult for these borrowers to refinance because they will no longer meet the more stringent loan-to-value ratios that will be required to refinance. It is likely many of these borrowers will not be able to afford the payment at reset, and they will lose their homes just as the subprime borrowers lost their homes. If Alt-A and prime borrowers had utilized conventional mortgages as they had in the past, they would not be facing the mortgage reset time bomb, and they could simply ride out the subprime debacle just as many homeowners did through the declines of the early 90s. However, it is different this time. This time, the loans they have taken out are going to ruin them. It's not the borrowers, it's the loans.
Both Darrin Roseborsky & Alex Gwen Thomson are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
Darrin Roseborsky has sinced written about articles on various topics from Finances, Credit Counseling and Credit Cards. Darrin Roseborsky is a Refinance Specialist with OMAC Mortgages, seminar speaker and president of the Roseborsky Group and . Darrin can help you. Darrin Roseborsky's top article generates over 27100 views. to your Favourites.
Alex Gwen Thomson has sinced written about articles on various topics from Home Management, Income Tax Return and Wrinkles. is the author of The Great Housing Bubble: Why Did House Prices Fall?Learn more and get FREE eBooks at:. Alex Gwen Thomson's top article generates over 673000 views. to your Favourites.