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Most home sales today begin with a mortgage on the home. Those who have purchased homes over the last several years may have adjustable rate mortgages, commonly known as ARM’s. This type of mortgage allows you to purchase a house, or so you’ve been lead to believe, for less out of pocket expense than a traditional mortgage.
In California, where the housing market remains as one of the top in the Nation, over 60% of the mortgages written in the last couple of years have been interest only, adjustable rate mortgages. As many people are starting to learn, these mortgages are becoming very, very expensive. It is expected that over the next year we will see an increasing amount of defaults on these types of mortgages. We may even see enough defaults that the property value may decrease as these homes are repossessed.
Let’s look at a probable example. We have a couple who wants to purchase a house. They think they can stretch and afford a payment of $1,700 per month for their new home. Our couple has managed to save $20,000 for a down payment and they know that they can afford a house for $270,000.
Two years ago the couple worked with a financial planner who helped them explore several types of mortgages. Both options presented by their planner were conventional mortgage options. Both mortgages had a fixed interest rate of 6% per year. The couple looked at both a fifteen and a thirty year fixed mortgage. The fifteen year payment would be $2,099 per month and the thirty year payment would have been $1,487 per month.
Immediately upon leaving the planners office, our couple went to their real estate agent to begin looking for their perfect home. Their real estate agent told them that there was yet another option for financing their home. The agent explained to our couple that with interest rates as low as they were, they could afford to a purchase a much larger home. They could do this using an interest only, adjustable rate mortgage (ARM).
The agent talked about the fantastically low rates that existed. Our couple was excited to hear about a 3% interest only loan they could qualify for. The agent showed the couple a $420,000 home they could purchase and have a mortgage payment of only $1,000 per month. The agent talked about how homes were a great investment and how they always went up in value. He also showed the couple that if interest rates did go up, they would have room in their budget for a higher mortgage.
Now we fast forward three years and it’s time for the annual adjustment that happens with adjustable rate mortgages. During the last two years, interest rates increased by 4% to 7%. This meant the new renewal rate for the couple’s interest only loan was now going to cost them $2,333 per month for their mortgage payment.
Remember, our couple only had the ability to pay $1,700 for their mortgage payment. They were faced with finding a way to come up with an additional $633 per month over and above what they could afford. Our couple managed to pay the extra amount for a few months. They then began to feel the stretch and started to let some of their other debt get a little behind. Over a period of time our couple accumulated a large amount of credit card debt, was behind on their car payments and couldn’t find anyplace to get extra money.
Our couple revisited their real estate agent. They had decided it was time to sell their house, take some profits and buy a less expensive place. They calculated their house would be worth at least $475,000 since the agent “promised” them an increase of 8% or more per year. However, the agent informed our couple that despite their calculations, the house was only worth $375,000 now and after their fees, they would only clear $350,000.
Our couple doesn’t know where to go. They couldn’t afford the ever increasing payments, couldn’t sell the house and their debt was getting out of control. Unfortunately, our couple will, at the very least, have a very rocky couple of years. At the worst, they will be looking at bankruptcy.
Had our couple followed their planner’s advice, they would have gone with a less expensive house and “fixed” their expense. If you have an adjustable rate mortgage, we strongly suggest you find a way to convert to a conventional mortgage. If you can’t afford a conventional rate mortgage, you should think about moving to a less expensive house today before interest rates go any higher.
We would be happy to discuss options for the financing of your home. We recently expanded our capability of helping our Clients choose and obtain the right mortgage. If you would like more information about this new capability, please contact us at your convenience. We would love to meet and discuss the options and dangers that exist with the different mortgages in the economic marketplace today and what’s right for you.
If you would like more information from our firm, please visit us online or e-mail us and a Stage 2 associate will get back to you.
With Warm Regards,
Stage 2 Planning Partners
Josh Patrick © 2006
Securities and Investment Advisory Services offered through NFP Securities, Inc., A Broker/Dealer, Member NASD/SIPC and a Federally Registered Investment Advisor.
Stage 2 Planning Partners is an affiliate of National Financial Partners Corp., The parent company of NFP Securities, Inc. Representatives listed on this website are currently registered to conduct securities business in the following states: AZ, CO, CT, FL, IL, IN, MA, MT, NC, NH, NY, PA, RI, VA, VT, WA
NFP Securities is not affiliated with Harris- Murray
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