Last Year's Great Mortgage is This Year's Disaster
The market for real estate in the United States seems to have
slowed down from the fever pitch of just a year ago. There are a
number of reasons for this; rising interest rates and sticker
shock among buyers are just two of them. Whatever the reasons,
sales of homes seem to be slowing, and that trend will probably
continue in the near future.
That being the case,
several types of loans that have recently been very popular have
suddenly become poor choices of financing for those buying
homes. While some types of loans, such as the 30 year,
fixed-rate mortgage, are usually safe choices, others, such as
the interest-only adjustable rate mortgage (ARM) and the Option
ARM have suddenly become not only poor choices, but potentially
dangerous ones, as well.
The interest-only ARM was a
great choice just a year or two ago among real estate investors.
It permitted the buyer to make low monthly payments for the
first few years of the loan that compensated the lender only for
the interest that accrued on the loan. Payments did not apply
even one cent towards reducing the principal. After a period of
3-5 years of interest-only payments, higher payments that
applied a portion to the principal would kick in. Buyers,
especially investors, weren't too worried about not paying
towards the principal, as prices were rising so rapidly that the
buyers were building equity in the property just the same. That
is no longer the case, and anyone who takes out an interest-only
mortgage today might find that, in five years time, he or she
owns just as little of the property as they do today.
The Option ARM is even worse in today's climate. This
somewhat flexible loan allows the buyer to make four choices
each month regarding how much to pay - a "minimum" payment, an
interest-only payment, a payment based upon a 30-year repayment
schedule and one based upon a 15-year repayment schedule. Those
who really cannot afford the house in question most often use
this type of loan. The touted "minimum" payment, which seems
quite small, is really misleading. That payment not only
contributes nothing towards the loan principal, but it doesn't
even cover that month's accruing interest on the loan. After
making a minimum payment, the outstanding balance on the loan
will actually increase. When prices were going up, this
type of loan was seen as bullish. With house prices stabilizing,
and even beginning to fall in some markets, this type of loan
will leave many borrowers owing more than their homes are worth.
As times change, so do the needs of homebuyers. At the
moment, it seems that housing prices are either stabilizing or
falling. That being the case, a loan designed for people in a
market where prices continually go up is probably a bad choice
today.