By Ryan C. Wood
Our country is still trying to overcome the mortgage meltdown and stop home after home from being foreclosed on. Adjustable rate mortgages (ARMs) were one the leading causes of the mortgage meltdown. ARMSs are exactly what they sound like. They are mortgages that do not have a fixed interest rate for the whole loan term. The typical adjustable rate mortgage lures an unsuspecting borrower in with a low fixed interest rate for the first five to ten years. After the fixed interest rate period the interest rate then becomes variable. Variable to a mortgage company means the interest rate will increase and you will have to make higher mortgage payments. Many new homeowners were able to afford the fixed monthly mortgage payments during the first five years, but when the interest rate adjusted up many homeowners could no longer afford to keep their homes. This led to thousands if not millions of foreclosures.
ARMs are being advertised as beneficial given that the average person only keeps a mortgage for a few years. So naturally you should pay a lower interest rate and therefore a lower mortgage payment. Then just get rid of the mortgage after five years by selling the home or refinancing the existing ARM. Okay, so why buy a house at all then? The home will probably not go up in value any time soon and you will now have the pleasure of paying property taxes and most likely pay more for utilities. These mortgages are also advertised as having more controls on them so that when the fixed period ends the mortgage cannot increase too much. Also there are no longer prepayment penalties with most adjustable rate mortgages.
So why are adjustable rate mortgages still being offered by lenders? The answer is simple, because mortgage companies make money off of them in the long run. They make money when you obtained the adjustable rate mortgage to purchase a home, and then make more money when you have to refinance or sell the home. In California, a homeowner is protected by what is called a purchase money security interest. An original mortgage that is obtained for the purchase of a home protects a homeowner in California if they can no longer make the mortgage payments. A mortgage company cannot seek any money from the ex-homeowner if they choose to walk away and the purchase money security interest is still in place. But what happens in the event of refinancing a home? The refinanced loan is not obtained to purchase the home, so no purchase money security interest and the mortgage company can seek any difference between the value of the house and what is owed at the time of foreclosure. To recap; the mortgage company made money by issuing the adjustable rate mortgage, then made money when you had to refinance the mortgage to a fixed rate mortgage so you could afford the payment again, and then you lost your ability to walk away from the home debt free by refinancing and the mortgage company can now make more money after they get the house back in foreclosure.
A major bank here in the Bay Area offers an adjustable rate mortgage that is fixed for the first five or seven years at 3.125 percent. After that the interest rate is described as projected. So what is a projected interest rate? The mortgage company provides the following definition: “The government requires us to display this information. So what does it mean? The Adjustable Rate Mortgage has a fixed rate and monthly payment for the first five or seven years. After that the rate can adjust up or down annually. As a result, we’re required to display what the rate and payment will be after the fixed rate period ends. Keep in mind, since we don’t know what rates will be in the future, the actual interest rate and payment may be higher or lower.” With interest rates at historical lows the interest rate on this loan will most likely increase significantly during the twenty-five years the interest rate can adjust. The question is will the person who chooses this loan be able to make the higher payments after the mortgage adjusts up? The last six years tells us no.
The only logical answer as to why adjustable rate mortgages are being sold by mortgage companies is mortgage companies make a lot of money issuing loans whether the homeowner is successful in making the payments long term or not. This is a transaction driven industry. Sell the original mortgage, refinance the mortgage, issue a line of credit, foreclose on the property, auction off the property and make money on each transaction.
For information about how bankruptcy can help homeowners in distress please contact our San Mateo bankruptcy attorney or San Jose bankruptcy attorney toll free at 877-963-9543 to schedule a free consultation.