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Adjustable Rate Mortgages and other Exotic Mortgages-
You may have noticed that some interest rates advertised are surprisingly low. These are usually Adjustable Rate Mortgages (ARMs). The payments may be low for a period a short as a year and then go up. This is what is called the initial rate, or the teaser rate. ARM payments go up when market interest rates go up, and go down when they go down. Also some loans put a ceiling on payments during one period, which may be different later. You need to know about other problems like negative amortization. This means that because you defer paying off the principal, and only pay off the interest on the mortgage, the amount of your principal actually goes up. Interest rates on ARMs are generally initially lower, but the lender may be betting that the index interest rate will go up, meaning your ARM interest rate will go up.
So ARMs have the advantage of making it easier to get initial financing to buy a home or condominium. In some cases, you may be intending to stay there for only two to five years, before the monthly payments increase. However, in a period of rising interest rates, ARMs are a bad option for buying a home you intend to stay in for five years or more. It also may make it impossible for you to build any equity, the portion you own clear of financing, in the home.
If your income is rising, then even if you have an ARM at first, you can later convert to a fixed 30-year mortgage, where the payments are the same throughout the life of the mortgage. It’s difficult to predict if interest rates will continue to rise, but it is a real possibility. Common indexes for the interest rate on an ARM include US Treasury Notes, the National Average mortgage rate, and the interest rate for jumbo CDs. Then a margin is added to that, to make your interest higher, in order to pay the mortgage broker’s cost.
Many economists have been concerned by the widespread use of ARM mortgages, IO mortgages and other exotic mortgages. The problem is that in many cases, such as under a high interest rate regime, these mortgages would never be paid off, even if the household managed to make the payments and avoid foreclosure on the mortgage. This is especially true with IO Mortgages. A family could manage to acquire a home, make the payments for the initial three to five year period. Then they would be forced to refinance the home with another IO Mortgage to keep up payments. And even to due this would be based on the housing market prices, their appraisal constantly going up. So for many people who barely were able to afford a home, this creates an inherently unstable situation, which could lead to a huge wave of foreclosures. So such a mortgage is ultimately only good for certain types of speculators and investors. If you want to buy a home to live in, as the permanent family home, it is not worth the risks.
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