Greg McBride, CFA, chief financial analyst for Bankrate.com, a personal-finance website that conducts annual nationwide surveys of fees at banks and credit unions, Palm Beach Gardens, Florida.
Home buyers, watch out! Financial institutions are rolling out a new generation of hybrid adjustable-rate mortgages (ARMs) with very attractive initial rates. ARMs allow home buyers to increase their buying power and keep monthly payments more affordable—but they were a major culprit leading to hundreds of thousands of foreclosures in the 2008 housing meltdown. The new ARMs recently carried rates as low as 3.16% for the first several years, compared with a nationwide average of 4.28% for a 30-year fixed-rate mortgage.
Lenders say that the new features reduce the risk that borrowers will get into trouble when the fixed-rate period of the ARM ends. These features include initial interest rates that remain fixed for longer than the typical five-year period, giving borrowers more time to refinance or sell the home before the rate adjusts upward.
Example: Pentagon Federal Credit Union recently offered an ARM with an interest rate of 3.625% for the first 15 years of the 30-year loan. The rate adjusts once after the 15 years. The new ARMs typically are capped at a maximum of five to six percentage points above the initial rate—in the case of the Pentagon Federal Credit Union ARM, the rate could rise by six points to 9.625%.
If you are considering an ARM…
Look at the maximum rate allowed over the life of the loan and how much the rate can rise each time it resets. Get help examining your mortgage terms and running the numbers from a nonprofit HUD-approved housing counselor (HUD.gov and put “Housing Counselor” and your state in the search box).
Avoid using an ARM as an excuse to buy an expensive house that you couldn’t afford with a fixed-rate mortgage. Even with an extended low-rate period, there’s too much risk that you will be caught flat-footed and potentially have to give up the house later when the loan resets.
What to do: Ask yourself whether you could handle higher mortgage payments if you weren’t able to refinance or sell your home before your payments adjusted upward.