Originally published
October 9, 2006
CNNMoney.com Tick. Tick. Beware
the mortgage time-bomb That ridiculously low-rate ARM seemed
like such a good idea at the time.
But now, payments will be coming
due in a big, big way.
By Jeanne Sahadi, CNNMoney.com senior
writer NEW YORK (CNNMoney.com) -- Mortgage
rates have been trending down,
but that won't do much to benefit
those who signed up for low-teaser-rate
adjustable-rate mortgages in the
past few years. An ARM charges an
initial discounted rate for a period
of time, after
which it adjusts to market levels.
When some types of ARMs with teaser
rates of 2 percent or less reset,
the rates are likely to jump to
more than 6 percent - and even as
high
as 9 percent. That can mean a doubling in monthly
payments owed for those homeowners
saddled with the loans. The jump in payments could be even
bigger for some people. They could
have a loan balance that's larger
today than it was when they got their
mortgage - a situation called negative
amortization. And it's common with
what are called "payment option" ARMs. That's because the initial teaser
rate is a "payment rate," not
an interest rate. That means the
market-rate interest on the loan
starts to accrue from the get-go
and monthly payments aren't enough
to cover it, let alone pay down any
of your principal. There may also be a trigger ceiling,
meaning when the balance reaches
a certain level - say 120 percent
of the original balance - the introductory
terms will end and the rate will
reset upward, according to Christopher
Cagan, director of research at First
American Real Estate Solutions, a
mortgage information provider. End result: A much higher interest
rate on a bigger loan than the homeowner
ever intended. In the past two years, homeowners
took out 1.3 million ARMs with teaser
rates below 2 percent, according
to Cagan's research. Of those, 21.5 percent have negative
equity, where the market value of
the home is less than the amount
owed. The number of people in that
spot could go up significantly if
home prices fall as forecast or if
homeowners with teaser-rate-ARMs
experience job loss, illness, divorce
or a death in the family, which are
the main causes of mortgage default. Certified financial planner Mari
Adam knows of a couple hit by this
mortgage nightmare first hand. With
two kids in college, the two-income
couple thought they could lighten
their load by refinancing their fixed-rate
mortgage into a low-rate ARM. They got a 1.2 percent ARM in February
with a monthly minimum payment of
$1,372. By April, the loan rate had
reset, jumping to 8.375 percent,
and their loan balance had ballooned
by $3,000 in just two months. Their new monthly payment: $2,216
if they want to pay interest-only
or $2,300 if they want to start paying
down principal as well. "I'd call this an obscene loan," Adam
said. The situation could have been much
worse, said Keith Gumbinger, vice
president of mortgage information
publisher HSH Associates. Some ARMs
will let you make payments at artificially
low rates for a few years. Plus, at least the couple cited
by Adam still have some equity left
- less than before but at least some,
Gumbinger noted. Others aren't so lucky. A lot end
up with negative equity. That makes
it very tough to refinance to a better
mortgage. Many struggle to make their new
inflated payments, putting them at
risk of foreclosure. And selling
may not be an option to cure the
financial headache given the recent
leveling off, or downturn, of home
prices in many markets. What you can do
If you're in a fix with your ARM,
you might: Get fixed:
Moving into a fixed-rate
mortgage is the best thing you can
do so long as you don't have negative
equity, agreed Gumbinger, Adam and
Cagan. If you've gotten your ARM recently,
call the servicing number on your
mortgage bill, let them know you've
been sold a bill of goods and ask
them if they can recharacterize your
loan - a process in which they change
the loan to a fixed-rate product
without going through all the steps
(and costs) involved in a full refinancing. But if your lender won't let you
recharacterize, which can be the
case if your loan has been sold to
someone else, you'll need to shop
around for the best refinancing deal. The latest average rate on a 30-year
fixed is 6.30 percent; on a 15-year
fixed, 5.98 percent. If fixed doesn't work, go for a
longer term ARM:
If you can't afford
the payments on a fixed-rate mortgage,
a 5-year ARM may be your next best
bet, Gumbinger said. With a 5-year
ARM, the initial rate stays in place
for five years, after which it will
adjust each year after that. The
latest average rate on a so-called
5/1 ARM is 6.10 percent. If even those payments would be
too much for you to handle, you could
opt for an interest-only 5/1 ARM,
or even an interest-only 3/1 ARM,
which are likely to have slightly
lower rates. Interest-only ARMs charge you the
interest owed on the loan, but you
don't pay down any principal. As
a result, you won't build equity
or reduce your loan balance, but
at least you won't add to it because
you're paying off the interest, Gumbinger
explained. And next time you want to buy a
home with a mortgage, be sure to
read all the documentation (footnotes
included), ask lots of questions
and, Adam said, remember, "when
someone offers you a below-market
or above-market rate, something is
wrong." |
