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Housing Boom Goes Bust - ARM Financing

Credit Wise (featured column)
by Jennifer Wallis

For several years now, the housing industry has been basking in the glow of low interest rates and record numbers of home buyers. For many, low interest rates meant greater opportunities than ever before. Consumers who never thought they could own a home found that buying their dream home was possible. Mortgage companies had hoards of borrowers lined up to buy their very own piece of real estate. Appraisers, realtors, and home improvement warehouses were making money hand over fist. Consumers who had higher rates were refinancing and taking out second mortgages and home equity loans.

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When rates were low many homebuyers signed up for adjustable rate mortgages. An adjustable rate mortgage (ARM) allows homeowners to borrow money at a lower rate that is fixed for a period of time (1, 3 5, 7, or 10 years) and then adjusts depending on the current market. When rates are low, ARMs can be a great idea. The problem is that you can’t possibly predict what interest rates will be in 10 years. Consumers that signed up for ARMS years ago are now finding it hard to make their mortgage payments once the fixed period ends. Many financial experts are warning of a possible recession like we experienced in the 1980’s. In 1985, mortgage interest rates were 12%. While many ARMs may limit the amount that an interest rate may change, here is one extreme example. If you obtain a $150,000 mortgage at 6% interest, your payment would be $899.00 per month. The same loan payment at 12% would be $1542.00 per month.

Homeowners that did not sufficiently plan to pay higher payments are now losing their homes. Foreclosures are up about 155%. For homeowners who end up paying late, credit issues may put refinancing out of reach. So, what do you do if you have an ARM and can’t predict what interest rates will do?

Planning ahead is important. If you know that you plan to stay in your home for 10 years or more, a fixed rate mortgage may be a better option for you. If you currently have an ARM that will become adjustable in a year or so and you still want to stay in your home, it may be a good idea to review refinancing options before your credit suffers. Some loans may have a prepayment penalty that will not allow you out of your loan early so be sure to read the fine print.

When times are good, none of us like to think that they may get bad again. We worked our way out of a recession in the 1980s and we can do it again. In the meantime, the housing market may be more of a gamble than it has been in recent years. It seems that as rates go up, supply is surpassing demand. If you plan to sell your home, be prepared for it to take longer than it has in the past. Many homeowners across the country find themselves taking a loss on their homes, just to unload it.

The best advice when buying your dream home is to play it safe. Keep your other debts low so that you have income to cover any increase in mortgage payments. Don’t buy more house than you can afford. At the first sign of trouble, seek help from a credit professional or refinance to a fixed rate. While fixed rate mortgages may be a little more costly initially, they certainly aren’t as much of a risk.

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Copyright © 2006 by Jennifer Wallis. All rights reserved.

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