Could you still afford your Home if your monthly payment went up by a third next year or doubled in three years?
Most ARM mortgages include two Caps. First, limits how much your interest rate can increase each time it adjusts (usually annually). Second, limits the total amount that the interest rate can rise over the life of the Mortgage. Typically, these limits are 2 percent each year, and up to 6 percent over the life of the loan. In addition, you probably have a number of years you get to wait before your ARM adjusts. If you got a mortgage with a really low rate, either you were incredibly lucky or you've got an ARM and are waiting to see where you rates end up.
If you hold an adjustable rate mortgage, you are gambling that interest rates will not go up in the future. Unless you are absolutely certain that interest rates are going to stay near their current historically low values. Since no one can be certain, you are taking a chance that rates will not go up. While caps might keep you from feeling the extreme effects of increasing interest rates, you could still see your Mortgage payments as much as double. In as little as 3 years, when your Mortgage Payment doubles, do you think you will still be able to afford your home? One possible alternative is to refinance your current ARM into a new one or a new fixed rate mortgage.
Are you hoping to refinance your way out of a risky ARM?
If you are counting on Refinancing to handle the interest rate risk of your ARM, you could be in for an unpleasant surprise. If your ARM rate works it's way up to say 8% that will be approximately the market rate for fixed rate mortgages. Most ARMs are setup to move with standard mortgage rates indexes that represent current going interest rates for some type of loans. You are kidding yourself if you think you will be able to get a mortgage at a discount to these rates without coming up with a big upfront payment.
Will negative Amortization wipe out your equity?
If you can keep your payment the same when interest rates go up, you've taken on an extremely risky mortgage that could wipe you out. Especially if you keep your payments low after rates rise for too long. To read more about the risk of these tricky deals, please click here. You need to know what you are facing before one of these tricky mortgages totally destroys your financial future.
So maybe you'll be able to sell your house if interest rates go up.
If interest rates are rising, do you really think you are going to be able to sell? At a profit?? First, where will you live if you sell your house to escape a nasty ARM? Second, one reason why prices are so high is that interest rates are low, if rates go up and prices down will you even be able to sell? If interest rates rise enough for you to need to sell your house, how can you expect that prices will stay high enough for you to break even?
Low interest rates have fueled the current real estate boom. If interest rates rise, we could see home prices drop by 5, 10, 20, maybe even 30 percent. If you put 5% down on your house, and your house price decreases by 30 percent, let's hope it rose by more that 30% over the time you've owned it. If not, you could lose money trying to escape this nasty ARM. If your ARM goes up, it is because available mortgage rates are just as high and refinancing won't work.
So, you've got an ARM - you are gambling that interest rates will remain where they are to today. But there have been long stretches when interest rates have been considerably higher than they are today. The Federal Reserve Bank (Alan Greenspan and company) has a lot to say about these rates and your discomfort doesn't matter to them.
One thing you can do to exploit the artificially low rates from an ARM to build up as much equity as you can. That way you improve your financial situation when you do refinance and if you need to sell you improve your chances to at least break.
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