Keeping the Collectors away

An ARM a Month Keeps the Collectors Away
By Landon McGehee

Originally conceived as a means for more affluent homeowners to keep your cash tied up in investments which would produce greater returns than the interest rates they'd be paying, Adjustable-Rate Mortgages have since come into much wider spread use, often as a means for people to live over their heads in homes they couldn't otherwise afford.

Speculative buyers who intended to resell their homes after they had appreciated are now stuck with depreciated homes instead, and feeling the pinch as well. With many of these ARM's reaching their recalculation points now, we're beginning to see the first wave of casualties, and the numbers will only continue to get worse from here.

Highlighting the first point are statistics recently released from the Federal Housing Finance Board. The generally accepted mortgage one can afford is on a house valued at 2 to 2.5 times their annual income. As the housing boom saw a drastic rise in prices this became next to impossible for the average family.

The average house was priced at $283,000, which would require an ideal salary range of $113,520 to $141,900, yet the median household income as of 2003 was just $43,350, meaning the average household can only realistically afford to mortgage a house valued in the $100,000 range. This has been circumvented by using an ARM, providing initially lower interest rates and flexible payment options

Whether home owners of modest means truly understood the implications of what would happen with their rates down the line is unknown. As short-term rates rise and the loan eventually gets recalculated to include the principal, the minimum per month amount owed can jump drastically, often as much as 50% or more, and often eclipse the rates one would owe through a fixed-rate mortgage.

This would seem to be simple math, by paying less than a fixed-rate mortgage for a length of time, it's only natural that one would eventually have fees that surpass it to make up the difference, but many homeowners have been caught off guard by the jump nonetheless.

This isn't to say that ARM's can't be useful and used wisely. When used with their original intent in mind, they can be powerful tools. On a mortgage in the $1 million dollar range, an interest-only mortgage could save the homeowner as much as $1,000 or more per month over a fixed-rate mortgage.

Those savings can then be reinvested with the intention of earning more than the interest rate owing. For people who move around a lot they can also be a great way to pay a minimum monthly amount, allowing them in effect to 'rent' a house for a period of time at a very reasonable rate.

Taking out an ARM or an interest-only loan is a risky proposition for those on the low end of the income bracket barely covering household expenses, and this is being proved in greater numbers as many home owners have been forced to abandon their homes with nothing to show for it due to being overwhelmed with readjusted rates.

As tempting as it can be to live above your means, the smokescreen and mirrors will eventually disappear, leaving you exposed and vulnerable. Be sure to plan ahead and take on a loan that will work for you both now and in the future.

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