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Thread: Got an adjustable rate? Get ready for big squeeze

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    Featured Member Vamp's Avatar
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    Post Got an adjustable rate? Get ready for big squeeze

    This is an article from a local paper here in michigan. It shows once again why adjustable rate mortgages are a bad idea.

    http://www.mlive.com/search/index.ss...ews?BUB&coll=2

    Just from an increase in the prime rate two percent can cost you hundreds of dollers a month in your mortgage payment.

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    God/dess Emily's Avatar
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    Default Re: Got an adjustable rate? Get ready for big squeeze

    it depends on the circumstances.

    Say you know you want to own a house for 5 years, or if you know you can pay off the mortgage in 5 years. It's a waste of money to pay a 30 year fixed rate.

    Generally, if you get an ARM so you can afford a house that you couldn't on a 30 yr fixed rate, it's a bad idea. I read the article...that's what they are describing. Also, many ARMs have caps on how far they can increase every year and overall. These people in this story are living beyond their means, which is BAD in general.

    I have a 5 year ARM and it works for me. I should have done the same on my first house, but I listened to all the naysayers that made "ARM" a dirty word.

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    Veteran Member leebay88's Avatar
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    Default Re: Got an adjustable rate? Get ready for big squeeze

    I did an adjustable rate 5 years ago. It actually adjusts every 6 months and is based off of LIBOR. I decided on this type of mortgage because I never planned on keeping the property for a long time. It was a gamble and worked out to my benefit. At one point the rate was below 2.5%.

    Right now I am giving my tenants notice that they have to move out and I will sell the place when they are gone. The rate has jumped up significantly but overall I made out very well (just good timing).

    For primary properties that you plan on settling in for a long time, adjustable rate mortgages can get you into trouble without the proper planning.

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    Default Re: Got an adjustable rate? Get ready for big squeeze

    The fear to the ultimate health of the US economy is that ...
    A. many recent home buyers chose ARM's as essentially the only way that they could afford to purchases houses at 'bubble' prices with monthly payments they could currently afford
    B. something like $600 billion worth of ARM's are due to readjust their interest rates and monthly payments upward in 2006, with over a trillion dollars worth readjusting in 2007
    C. with slow wage increases for people who still have 'good paying' jobs, with tens of thousands of 'good paying' jobs being abolished or outsourced (Ford announced another 30,000 job cuts today), and with monthly ARM payments due to increase by $200 or $300 or more per month, thus repossessions, forced sales, and bankruptcies are likely to skyrocket over the next two years.
    D. The rising number of bankruptcies will force mortgage lenders to tighten their credit standards, effectively removing willing buyers from the housing market due to lack of financing. At the same time, forced sales of foreclosed houses will depress real estate prices. Combining these two factors will put tremendous pressure on recent ARM home buyers who may find that they now owe more in ARM principal than their house can be sold for on the open market, they cannot afford to make the increased monthly payments on their ARM's as interest rates adjust upwards, and they also do not qualify for any form of refinancing under 'beneficial' terms.
    E. the 'deflation' of housing prices, and the resulting decline in the construction industry, the banking industry, home furnishings manufacturers and retailers, and all other goods and services providers related to housing, will simply be huge - very likely forcing over a million people into bankruptcy (under new bankruptcy laws) and throwing the American economy into a recession.

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    Featured Member Vamp's Avatar
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    Default Re: Got an adjustable rate? Get ready for big squeeze

    The problem comes in though if you can't sell your house during the time frame you want. The housing market is in decline. Partly because of predatory lenders who are giving mortgages to people living outside of their means. Rates are increasing. Some areas will be hit harder than others. When I gamble it is on a calculated risk.

    Emily in your example you talked about five years. In the next five years rates will continue to increase. If your income level changes it could be a large gamble.

    Great points Melonie

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    Default Re: Got an adjustable rate? Get ready for big squeeze

    ^ That's why you stay on top of the game and re-finance BEFORE your old Mortgage rate lock cashes in. It's what we did, and we still have a lower rate than most of our friends with fixed rates. We were only planning on staying here for a few years, anyways. Our new rate is locked for 3 years. We'll be out of here in less than 1 year.

    If you are looking to buy a house and stay in it for 30 years, a fixed rate would be a good way to go. However, even if you decide to stay in the house for 30 years, if you follow the rates closely you can still flip over to a fixed if you are afraid of the rates going too high. Otherwise, you can refinance every few years when the locked rate is about to expire.

    Depending on which way you look at it, it can either be a good thing or a bad thing.

    There's always more than one way to skin a cat.

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    Default Re: Got an adjustable rate? Get ready for big squeeze

    Otherwise, you can refinance every few years when the locked rate is about to expire
    As discussed in other threads, two dangerous assumptions underly this approach.

    #1 refinancing assumes that the market value of the home doesn't drop very much, such that a lender will be willing to write a new mortgage equal to the outstanding balance of the old mortgage based on the future resale value of the property providing adequate collateral. If not, then the homeowner will be stuck ponying up significant extra cash to refi with a smaller outstanding balance and provide the lender more equity margin if they want to refi.

    Imagine the poor fools who paid say $500k with next to nothing say $25k down for a nice house in a 'bubble' area a couple of years back, whose 3 year ARM is due to reset in 2007. Since the purchase they have paid down the principal by say $25k, leaving an outstanding balance of say $450k. However, the local real estate market will have softened up to the point that the 2007 resale price of the same home is now only say $400k. This guy is going to have to cough up an additional $50k minimum to get his loan 'above water' before a refi lender is even going to consider his loan application.

    #2 refinancing assumes that the relationship of future disposable incomes versus future interest rates versus future mortgage lender credit standards versus future cost of living factors (energy prices, tax rates, etc.) will allow the homeowner to qualify for a new loan in the future on 'beneficial' refi terms. A laid off auto / IT / real estate worker whose take home pay winds up dropping 20-30-40% is simply not going to qualify for a future refi on an ARM they could barely afford making monthly payments on while they held their former better paying job.

    In terms of recent history (say the last 10 years), both of these assumptions could pretty well be taken for granted ... ie. that housing market prices would keep going up, and that people with 'good' jobs had job security (or at least the ability to find a new job at an equivalent pay rate). However it would appear that both of these assumptions are now being brought into question in a big way, at least in particular housing markets and in particular industries.
    ~
    Last edited by Melonie; 01-23-2006 at 06:18 PM.

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    Default Re: Got an adjustable rate? Get ready for big squeeze

    Quote Originally Posted by Vamp
    Emily in your example you talked about five years. In the next five years rates will continue to increase. If your income level changes it could be a large gamble.
    I'm not sure you fully understand ARMs. You get a locked period for a certain time. a 5-year ARM is locked for 5 years. There is no increase until after that 5 years and by then I will have paid it off. I could pay an interest rate .5% higher, but why would I want to?

    There is no gamble here. I know what I'm paying to live. I guess if I have a drastic drop in income, I'm screwed, but how would a 30-year fixed change that?

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    Default Re: Got an adjustable rate? Get ready for big squeeze

    paying off a mortgage in 5 years is a major accomplishment ! congrats if you are able to pull off this feat. Unfortunately, most ARM borrowers will need every bit of their 30 years to do so !

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    Default Re: Got an adjustable rate? Get ready for big squeeze

    Quote Originally Posted by Melonie
    As discussed in other threads, two dangerous assumptions underly this approach.

    #1 refinancing assumes that the market value of the home doesn't drop very much, such that a lender will be willing to write a new mortgage equal to the outstanding balance of the old mortgage based on the future resale value of the property providing adequate collateral. If not, then the homeowner will be stuck ponying up significant extra cash to refi with a smaller outstanding balance and provide the lender more equity margin if they want to refi.

    Imagine the poor fools who paid say $500k with next to nothing say $25k down for a nice house in a 'bubble' area a couple of years back, whose 3 year ARM is due to reset in 2007. Since the purchase they have paid down the principal by say $25k, leaving an outstanding balance of say $450k. However, the local real estate market will have softened up to the point that the 2007 resale price of the same home is now only say $400k. This guy is going to have to cough up an additional $50k minimum to get his loan 'above water' before a refi lender is even going to consider his loan application.

    #2 refinancing assumes that the relationship of future disposable incomes versus future interest rates versus future mortgage lender credit standards versus future cost of living factors (energy prices, tax rates, etc.) will allow the homeowner to qualify for a new loan in the future on 'beneficial' refi terms. A laid off auto / IT / real estate worker whose take home pay winds up dropping 20-30-40% is simply not going to qualify for a future refi on an ARM they could barely afford making monthly payments on while they held their former better paying job.

    In terms of recent history (say the last 10 years), both of these assumptions could pretty well be taken for granted ... ie. that housing market prices would keep going up, and that people with 'good' jobs had job security (or at least the ability to find a new job at an equivalent pay rate). However it would appear that both of these assumptions are now being brought into question in a big way, at least in particular housing markets and in particular industries.
    ~
    You are so stuck on this housing bubble pop you are being blinded by reality. yes, there are some areas in which the homes are WAY over-valued. However, smart people do research into their home areas and evaluate values. While our home market is high, it is still "within" reason. There is no housing bubble in our suburb of Chicago. Our home value is not going to drop off. Places like California? Yes, it's going to burst BIG TIME. But the only time a housing bubble takes place is when the AVERAGE price of a home is unaffordable to the "average" person. So, in order for someone to live anywhere, they would have to make 4-5 times as much as they are currently making just to make ends meet and afford a nice, average sized home. THAT is a bubble. Not every place and town in the country has a bubble. And, if you do not want to be caught in a bubble you do your research, first.

    This has nothing to do with ARMs. Getting a 30 year fixed is a risk as well. Nothing in mortgages is "fixed" and cannot be redone if something goes wrong. Scorpio and I have paid more than 1/2 of our mortgage...yes, using ARMs. Like anything else in this world, if you want to play the game, learn the rules.

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    Default Re: Got an adjustable rate? Get ready for big squeeze

    This has nothing to do with ARMs. Getting a 30 year fixed is a risk as well. Nothing in mortgages is "fixed" and cannot be redone if something goes wrong. Scorpio and I have paid more than 1/2 of our mortgage...yes, using ARMs. Like anything else in this world, if you want to play the game, learn the rules
    Venus I appreciate what you are saying, and I also appreciate the fact that you and Scorp and many others do understand local real estate markets and local risk factors, and have been able to 'play the game' with ARM's under favorable rules. However, I'm sure that you'll admit that the rules that you and Scorp were able to play by over the past decade are not necessarily the same rules in effect today for a first time home buyer - and particularly not for a first time home buyer who is 'light' on down payment and/or FICO score.

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    Default Re: Got an adjustable rate? Get ready for big squeeze

    Quote Originally Posted by Melonie
    Venus I appreciate what you are saying, and I also appreciate the fact that you and Scorp and many others do understand local real estate markets and local risk factors, and have been able to 'play the game' with ARM's under favorable rules. However, I'm sure that you'll admit that the rules that you and Scorp were able to play by over the past decade are not necessarily the same rules in effect today for a first time home buyer - and particularly not for a first time home buyer who is 'light' on down payment and/or FICO score.
    The rules have changed...and they change constantly. However, there are programs out there for people who are "light" on down payment and/or FICO scores. They'll pay more, but that doesn't mean that they cannot get a loan or cannot play the game. The problem with most people these days is that they do not educate themselves in the finer points of the game. To them, it's buy a house, make house payment. That's it. When it really should be Find a house, study the trends, look at the current market, find a lender, figure out your payment/pay-outs, select best program for your own needs, close on the house...and keep watching the trends/market.

    Most people want the "duh-proof" programs. Buying a home is a HUGE risk, in and of itself...this has nothing to do with mortgages. It has everything to do with the amount of knowledge (or lack of knowledge) that homeowners have.

    ARMs, Fixed Rates, etc, etc, etc will always be around, and if the game is played right, you'll always win. A mortgage is not a guarantee that you'll keep your house. If the feds were to raise the base rate to 22% and all ARMs went up from there...it would cause the collapse of the economy and every one who had a fixed rate would find that their loans are being called in. Having a fixed rate simply means that you pay x% for 30 years. Having an ARM means that you pay x% for x years before it begins adjusting, but you can avoid the adjustment period by refinancing either into a fixed or another ARM.

    Like I said before, the rules of the game has changed, but the "stakes" aren't that the rates are going to go so high that you cannot afford the mortgage. Because, if you are playing with ARMs, you are, or should be, watching the game and can refinance anytime when you feel "wrong" about the game.

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    Default Re: Got an adjustable rate? Get ready for big squeeze

    you are, or should be, watching the game and can refinance anytime when you feel "wrong" about the game
    Again I seem to be missing something. Certainly you can refinance at will, given the fact that you have a great FICO score plus 50% equity in your home compared to the current market assessed value of your property. But just how exactly does someone who purchased a home 2 years ago with 5% down, and who has at most built 2-3% equity beyond the initial 5% down payment, get refinanced if the current market assessed value of their property has declined 10% from when they purchased it ?

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    Default Re: Got an adjustable rate? Get ready for big squeeze

    Circumstances vary a lot...

    ARM saved me a lot of money over the years. In the next 6 or less years, if the variable interest rate is close to or above what I could have gotten a fixed rate at, years ago, I will still make out. Also as a person's income increases over the years, s/he can start prepaying with some extra principal. For what I'd save by refinancing the remaining principal at a slightly favorable fixed rate for the remaining period, whenever that comes about, it would likely be wiped out by the cost involved (transfer taxes, legal fees, origination fee, points, etc.).
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