Adjustable Rate Mortgages: Buyer Beware

Posted by Nick Niesen on October 29th, 2010

Remember when your mom told you that if it sounds too good to be true, it probably is? The same could be said about Adjustable Rate Mortgages (or ARM in industry lingo). These guys can be a wolf dressed in sheep's clothing and if you aren't careful they are going to huff and puff and take your home away!

An Adjustable Rate Mortgage works like this. Initially, you are probably going to be paying anywhere from 2 - 3 % below the current market interest rates on your mortage. For many people, this allows them to buy a bigger house, one that would normally be outside their price range. The normal reasoning is that by the time the loan adjusts - which could be a year from now, or as much as 7 - 10 years from now - they will be earning more, the economy will be better, etc.

The problem they run into is that as good as we hope the future is - sometimes it isn't. Lives change, the economy fumbles or we change jobs. Suddenly, we went from two incomes to one or we just aren't making as much as we were a few years back. Even worse, interest rates rise and when it comes time for our ARM to adjust it goes up - way up.

Some ARM's adjust every year and are based off current interest rates set by the Federal Reserve. Sometimes, this can be a good thing as interest rates may have fallen and you could end up paying in interest than you were at the start of your loan. However, as is most often the case, the exact opposite is true - interest rates have risen, and you end up paying more each month. The budget starts to get stretched a little thinner.

There are other ARM's that adjust after a specified number of years - say 7 to 10. When they finally kick it, it can be a real sticker shock for the homeowner. If they haven't planned for this financially it could mean the difference between them keeping or losing their home. In some cases, monthly mortgage payments could double in size depending on how low your interest rate was before the adjustment and what current interest rates are.

So what's the smart move for most home owners? Stick with traditional mortgages that have a predefined interest rate that is locked in over the life of the loan. If market conditions warrant sometime down the road, you can always look into refinancing your mortgage and getting a lower interest rate.
Adjustable rate mortgages are good for those who like to gamble - and some argue they are good for families just starting out who know they will need a bigger house in the future and will have larger incomes in the future as well. However, as we all know, nothing is as certain in life as change and sometimes the smart homeowner knows when to play it safe and keep a roof over his or her head!