I keep reading about all the people that are one step from doomsday. Most of these people are dealing with adjustable rate mortgage increases. Why did they get an adjustable rate mortgage in the last couple years? From a purely financial perspective, it seemed like a riskier approach because interest rates were some of the lowest in 40 years. I can appreciate that the low house payments were tempting, but I guess I’m just too risk averse.
At first I heard mostly about people with 1st mortgages that were adjusting up as the fed increased interest rates. Now I seem to be reading more about people with adjustable rate home equity loans. To me, that just seems tragic. For the people that took large sums of equity out of their homes to purchase things, or increase their standard of living, it just doesn’t seem too rational. They may have put their homes at risk because they didn’t have the self control to live within their means. Now, obviously there are exceptions to this. I’m sure there are people that had to take out some home equity to cover emergencies, health costs etc. Certainly they did what they had to do.
What I find intriguing about these adjustable rate equity lines and mortgages is that I find it hard to believe that the mortgage companies didn’t know that they were setting these people up for a big fall. I read an article in the paper today that said mortgage companies were trying to give more advanced notice to their customers when they were raising their rates. Well, that’s nice. “Okay Mr. Customer. Hold on. We are going to hit you with a doozie in 4 weeks. No need to thank us for the warning. We do it because we love you. Oh, yeah, by the way, your rate is going up by 2% and you are probably going to lose your house. Have a nice day.”
The lesson that I’ve learned is that I’m always going to plan for the long game. I know that many people have used the rationale that they don’t plan on being in a house for more than 5 years so they get the lower adjustable rate mortgage for a lower payment and to pay less interest. It’s a valid point of view. If I had gotten an adjustable rate mortgage on my first house, I would have saved myself a few thousand dollars over the nearly 5 years we lived there. Looking back, I don’t think I’d change anything though because I never knew for sure what the future held for me. A million things could have happened that would have forced me to stay in that house. Luckily they didn’t. Now, we are in a house that we hope to live in for quite some time. I’ve got a 30 year fixed interest rate and am grateful for a stable payment (with the exception of my property taxes raising my payment each year)
It’s really strange to us *down under* how US mortgages are generally 30 year fixed rate… here in Oz nearly ALL mortgages are variable rate, and everyone get on just fine. Well, some people DO go broke – but generally only if they’ve borrowed a lot to invest in residential rental properties and assumed that property always goes up, and rates never do. Or they’ve bought way more house than they can really afford! ;)
Generally a fixed rate loan (here only available for 5 year terms generally – then you have to refinance or rollover for another term at the current fixed rate) is 0.5% to 1.0% higher than the variable rates available.
Comparisons of fixed rate vs. variable over the past 30 years or so has shown that 9 times out of 10 you’ll be ahead with the variable rate.
As you say, a fixed rate is shifting risk from you to the lender – so they build in a margin to more than compensate for absorbing the risk!
ps. Variable loan rates usually go up and down in 0.25% increments – in relation to the changes by the central bank. If rates go up a lot, it’s usually because inflation is taking off, so your wages will probably keep pace over the medium term. It can cause problems if you didn’t allow for a possible increase when taking out the loan – most people allow for at least a 0.5% increase when working out the loan they can afford to service.
I just refinanced my home mortgage a few months ago. Others that continue to have ARMs need to refinance now. Interest only loans are just plain scary.
I don’t know if ARM’s are any more dangerous to wealth than $0 downpayments and 100% re-finances.
None are great for the average person.
Indeed this seems like win – loose situation and certainly the house owner is not the one that wins in this case. In fact the big spenders could go below bankruptcy because of the ARM. I’m just glad I don’t have one.
Ralph, I don’t doubt that most homebuyers have been better off with ARMs over the past 30 years. 30 years ago, in 1976, we had double digit interest rates. They fluctuated as they always do, but generally trended down for the next 30 years. We recently saw multi generational lows in int rates.
Hazzard, sadly many of those HELOCs were not necessarily used for conspicuous consumption directly, but as a piggy back loan for those with 0% down. Looks like they would have been better off financing 100% and paying PMI.
I have an ARM and I’m going to write on my blog later why I love my ARM. Low interest, moving within the 7 years, and I hate townhouse living (forced to because of price), but I want a single family one day. So I got an ARM because I knew where I would be in 7 years. But even if we didn’t move we could still afford it with the lifetime cap of 5%, currently 4.25% and lifetime 9.25%. Not bad at all. Also after 7 years I’d have payed down a nice chunk $60k of principal by just regular payments, I did the calculation in my blog.