The option ARMs, in particular, lured borrowers in with low initial interest rates - so-called teaser rates - sometimes as low as one percent. But after two, three or five years those rates "reset." They went up. And so did the monthly payment. A mortgage of $800 dollars a month could easily jump to $1,500.
Last night 60 minutes did another gloom and doom report on housing. The report focused on the next waive of foreclosures. "The Option Arm" They reported that the fallout from homeowners with option arms will be much worse than the sub-prime fallout.
I felt the report was irresponsible. They never explained how an option arm works. All they did was report that when they re-adjust millions of people will be in foreclosure. Maybe that will be true. If someone bought more home than they can afford most likely they will run into trouble regardless of the loan product.
The report never mentioned that when the option arms re-set they are re-set to current interest rates. Interest rates are at all time lows. They also never mentioned the benefit of option arms and that they were designed for people who's income fluctuates such as business owners, independent contractors or those who are paid commission. The homeowner has the option of paying either a fixed interest only or a higher interest and principle every month. For responsible borrowers the option arm is a great product.
I'm pretty conservative financially and I always explain the risks involved with buying a home and financing it with my clients. There is always a risk involved. While I'm familiar with option arms I'm not familiar with any one so naive that they got an introductory rate at 1% and didn't know it would go up. Perhaps there are many of those loans out there and when they adjust to 5% the homeowner will be in trouble. IMHO that homeowner was never qualified to buy the home in the first place if they could not be approved at the possible future higher rate.
I bought a home in 1989 at the top of the last boom. The developer of the building that I purchased required buyers to be approved by their bank Citibank. I was approved by citibank at their prevailing rate of 10 1/4%. Once a buyer was approved by Citibank they were allowed to get financing elsewhere. I shopped around and found a bank that offered an option arm at an introductory rate of 7 1/4%. It readjusted every year and included the risk of negative amortization. I was fully aware of the risks but felt it was a good product for me. It turned out to be a great product.
During the early 90's real estate prices dropped about 30%. My home was worth less than I paid. Comparable apartments were being sold for much less. At the same time interest rates were rising and my mortgage payments increased. However, I had the 3 options every month. I could either pay the fixed rate (interest only) or interest and principle or fully amortized payment. There were some months that I only could pay the lower amount. I was happy to have that option. I enjoyed the apartment and wasn't very concerned about "the market" because I wasn't planning on selling. I was planning on living there. I enjoyed it just as much when it was worth 30% less. It was still a home that I enjoyed.
It turned out after a few years interest rates started going down. My mortgage payments became less and less over the years. My rate went from a high of 12% to a low of 5%. During this time period many of my friends and acquaintances refinanced and refinanced. I only planned on refinancing if rates starting climbing up. It never became necessary. I sold the place and paid off the mortgage. I'm now in the market to buy again. Since it has been two years since I owned I am considered a "first time buyer" and will be eligible for the 4.5% first time buyer rate.
Real estate is cyclical. It goes up it goes down. Interest rates go up and down. Know what you are getting into. A home is not a portfolio. It is a place to live and enjoy. It is something that should be held for the long term. Market conditions should not determine when to buy personal conditions should.
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