And NO, we’re not talking about the dangers of optional human arms here.
Those darn minimum monthly payments have moved from the credit card industry to the mortgage industry, and the situation is wreaking havoc on people’s financial lives. First-time homeowners are losing their houses because they can’t make payments, forcing people to sell or go into foreclosure. This is leaving homeowners asking the big question, “Why did we ever choose the optional ARM?”
What Are Optional ARMs?
The mortgage industry has two main types of loans granted to home buyers: fixed-rate mortgages and adjustable-rate mortgages (also known as ARMs). The key word to consider here is “adjustable.” With an ARM, the interest rate will rise and fall based on the state of the current market. Homeowners enjoy a fixed rate for a certain number of years and then the interest will adjust accordingly.
ARMs come in many different types and terms. One of the most popular, the optional ARM, allows the homeowner flexibility in making payments with a choice of low monthly payments, interest-only payments or fully amortized payments.
What’s Wrong with Optional ARMs?
You may be wondering what is so bad about optional ARMs — after all, they sound like a good deal where you can choose the best option that fits into your finances. Well, consider something similar that happened with the credit card industry that is now happening with the mortgage industry.
Credit card lenders allowed people to make the bare minimum payments to lower their card balances. The problem with this is that the minimum monthly payment wasn’t lowering the balance on the credit card. Instead, the payments went to lowering the card’s interest and associated fees. Even then, the minimum payment barely covered those items as the amount owed on the credit card grew. People making only the minimum payments.found themselves going deeper and deeper into credit debt that would take many years to pay off.
Optional ARMs carry the same type of risk. If you choose to make only the minimum payments, those payments will be applied to lowering the interest. Unfortunately, they won’t cover the entire interest owed, as what is left is added to the growing loan balance. Your mortgage debt will continue to increase each month from the interest that wasn’t covered by the monthly payment.
What makes the situation worse is that the minimum payment will increase during the adjustment period to ensure that the loan will be paid during the stated term period. So you could find yourself paying 50 percent or more in higher loan payments along with a higher interest rate.
Not only are you now paying a larger mortgage balance from the leftover unpaid interest, but now you must make higher payments.You may find this too much of a financial hardship — and worse, you haven’t built any equity in the home because you made only the minimum payments.
When Is It a Good Idea to Get an Optional ARM?
If you are financially secure and can afford to pay more than the minimum payment, you may well consider getting an optional ARM. Having the option to choose the amount of your payments — so long as they don’t go below the minimum — is still very appealing.
But you need to keep track of your payments, the amount of the interest owed and your mortgage balance to ensure you are paying things off. Also, have funds ready for the rise in your interest rate and payments when the adjustable rate kicks in several years later. Preparing for these eventualities will allow you to keep up with your mortgage as you take the necessary steps to homeownership.