Has Your Adjustable Rate Mortgage Become a Gamble?

The Impact of Rising Interest Rates on Adjustable Rate Mortgages

Three or four years ago, interest rates on home loans dropped to levels not seen since the 1960s. Millions of Americans took advantage of the favourable rates, which bottomed out near 5% for fixed-rate, 30-year loans. For adjustable-rate mortgages (ARMs), the rates were even lower. Many buyers passed on the opportunity to lock in at fixed rates and gambled on the lower payments afforded by adjustable-rate loans in order to buy either larger or more expensive homes. This strategy worked fine at the time, as the rates kept the monthly payments affordable. However, the sixteen increases in the Federal interest rates since 2004 are about to have a dramatic effect on those buyers, many of whom may find out that they can no longer afford to pay for the homes in which they live.

Many adjustable-rate loans are set up in such a way that the interest rate is fixed for the first three years of the loan's repayment schedule. After that, the interest rate adjusts regularly, based upon prevailing market rates. For the millions of homeowners who gambled and took out these loans in 2003, the Big Adjustment is going to come soon, and it isn't going to be pretty. As the rates adjust to current levels from the low rates of 2003, many homeowners are going to be shocked to see their monthly payments rise by as much as 50%. Some will be fine with that, having anticipated this increase for some time. Others will suddenly find themselves unable to pay for a house they have long thought they could afford. This will undoubtedly lead to an increase in the foreclosure rate, which is already some 60% above the rate of last year. In Michigan, the rate is up by 90% over last year, as hundreds of owners have walked away from their home loans.

What can you do if you have an adjustable-rate loan that is about to become unaffordable and may yet become even more so? Your best bet may be to refinance and take out a 15 or 30-year fixed-rate loan. The benefit of doing so is the security that comes with knowing that your payment will remain stable over a long period of time, no matter what happens to the interest rates in the marketplace. If you cannot afford your loan now and refinancing with a fixed-rate loan will still leave the payments unaffordable, you may have no choice but to sell the property and move to something smaller and/or less expensive. You will not be alone.