Why Adjustable Rate Mortgages (ARMs) Are A Bad Idea
3 October 2006There’s a Business Week article I just came across about a pretty widespread problem rising interest rates are causing: adjustable rate mortgages are starting to adjust, making housing payments unaffordable for many people who used them to finance more house than they could really afford. I think this article is great because it simplifies what is an extremely complicated financial instrument and lets you understand what the problem is without having a finance degree. If you don’t have an ARM yourself, then you may not need to know much more than “they’re really risky and you shouldn’t get one.” But it does have broader implications for other financial decisions you might make.
For one, the information on how mortgage brokers operate is useful even if you don’t have an ARM. Most of the people who got into these problems did so because they didn’t read the fine print – they trusted the advertising or verbal assurances which turned out not to disclose everything. And people are still buying these – some states have up to 50% of new mortgages being set up as ARM’s. The problem is essentially that while there is a low minimum payment, by making it you’re adding money onto your balance (whereas a normal mortgage gets lower each month). Over time, that causes a big problem – and interest rate shifts make it worse because your rate isn’t tied down. As the article points out, this might also affect you by pushing down the value of your house – as people with ARM’s are forced to sell, many areas could end up as buyer’s markets.
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