Scary Days Could be Ahead for Adjustable-Rate Mortgages
USA Today - Sandra Block
April 4, 2005

For millions of homeowners with adjustable-rate mortgages, it's gut-check time.

Short-term interest rates have been rising steadily since they dipped to record lows last spring. The average initial rate for a one-year ARM is now 4.33%, up from 3.46% a year ago, according to mortgage giant Freddie Mac. So if your one-year ARM is about to hit its first birthday, you're going to have to dig deeper to pay the monthly mortgage bill.

Most ARMs contain caps on how much their rates can increase each year. But even with those limits, an adjustment can be painful.

Many borrowers who took out a one-year ARM at 3.5% last year will see their rate adjust to about 5.5%, says Keith Gumbinger, vice president of HSH Associates, a mortgage-consulting firm. On a $250,000 mortgage, that works out to an additional $297 a month.

Borrowers who used short-term ARMs to buy homes they couldn't otherwise afford may find themselves unable to make the higher payments, says Barry Glassman, a financial planner with Cassaday & Co. in McLean, Va.

Despite the risks of a big upward adjustment, ARMs are more popular than ever. More than 36% of mortgages had adjustable rates last week, according to the Mortgage Bankers Association. That's the highest since the trade group began tracking adjustable-rate mortgages in 1990.

Economists say rising rates for 30-year fixed-rate mortgages have stoked the popularity of ARMs.

The average rate for a 30-year fixed-rate mortgage was 6.04% last week, the highest since June.

In addition, homeowners have become more sophisticated about mortgage products, says David Lewis, executive vice president of ING Direct.

"There are a lot more people questioning the prevailing wisdom" of traditional fixed-rate mortgages," Lewis says. "Many don't plan to stay in their homes for more than a few years and are unwilling to pay a premium for a 30-year fixed rate," he says.

How to Cope

Whether you have an adjustable-rate mortgage or are considering one, new strategies are in order. Tips for folks who have an ARM and are getting nervous:

There are lots of mortgage calculators on the Internet that let you calculate how a rate increase will affect your monthly payment.

Freddie Mac has several useful tools at www.freddiemac.com.

Use the calculators to figure out what will happen to your payments if your interest rate rises to 4%, 6% or even 7%, Glassman says.

For example, if your initial rate was 2.75% and your lifetime cap is 6 percentage points, you'll never pay more than 8.75%, no matter how much rates rise.

The annual caps give you some breathing room, says David Herpers, director of consumer affairs for mortgage lender Amerisave.

If you took out an ARM when rates were low, the rate after your first adjustment will probably still be lower than the rate for a 30-year fixed mortgage, he says.

If you think you're going to move in a couple of years, you may be better off just sticking it out.

You probably won't lower your rate, but you'll avoid another shock next year, Gumbinger says. The average rate on a five-year hybrid ARM is now 5.66%, he says.

While that may be higher than the adjusted rate for your one-year ARM, "At least you can feel secure that you're not going to have worse pain coming," he says.

Risky Business

If you're shopping for a mortgage, think hard about the potential risks of a one-year ARM. To keep inflation in check, the Federal Reserve is expected to continue raising short-term interest rates through 2005.

For borrowers who can afford a longer-term mortgage but want to free up cash for other purposes, a one-year ARM might make sense, Lewis says. But if a short-term ARM is the only way you can afford the payments, you can't afford the house, he says.

A five-year hybrid ARM carries a higher rate, but it's a "more reasonable gamble," Gumbinger says. By the time it adjusts, there's a good chance that "you'll have either moved, or we may be on the downward side of an interest rate spiral."

Amerisave is one of the nation's leading and fastest-growing online mortgage companies, serving customers in all 50 states and DC via its website, www.amerisave.com. Amerisave's mission is to provide the best rates from top banks for a variety of home financing needs. The company provides customers the ability to obtain the most competitive rates instantly via the Web. Amerisave offers a $300 guarantee that consumers will not find a mortgage loan at lower cost in rates and fees.