Tuesday, August 21, 2018
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Higher rates for ARMs squeezing some homeowners

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Adjustable rate mortgages are typically tied to the Treasury Bill rate or the prime rate. When these rates go up, so does the ARM rate. (MPR Photo/Brandt Williams)
Short term interest rates continue to rise. And that means Americans are paying more to borrow money for credit cards and home equity loans. It also means that monthly payments for adjustable rate mortgages are going up.

Minneapolis, Minn. — There are scores of different adjustable rate mortgages (ARMs) available today. There are one-year, three-year, five-, seven- and 10-year ARMs.

They can account for the entirety or a portion of a mortgage. For example, if a homeowner buys a house with a three-year ARM, then for three years the interest rate is fixed. And that rate is sometimes a good deal lower than rates for a 30-year fixed mortgage.

Bloomington-based mortgage broker Eric Olson says an ARM offers some advantages.

"If a person says I don't have that much to pay each month, you try to find a way to lower their monthly payment, that's usually by trying to lower their interest rate," says Olson. "The best way to do that is through adjustable rate mortgages."

However, if a person continues a loan longer than the fixed rate portion of the ARM, the interest on that mortgage may go even higher than the rate for a fixed 30-year mortgage. Adjustable rate mortgages are typically tied to the Treasury Bill rate or the prime rate. When these rates go up, so does the ARM rate.

"Let's say you started off with a 5 percent ARM," says Olson. "That's pretty low. On a $200,000 loan amount, that monthly payment for principal and interest is $1,074. Some of these ARMs will adjust only a maximum of only 2 percent each year as your loan goes. Regardless of what the underlying rate is, your rate is only going to go up 2 percent. But even that can be fairly substantial. In this instance it goes up from $1,074 to $1,330."

That increase of $250 a month is just the first adjustment. Under this scenario, if the loan continues for another year, the homeowner can face another 2 percent increase in interest. So that initial mortgage interest rate of 5 percent would become 9 percent.

But even much smaller increases in mortgage payments can be problematic.

John and Jennifer DeKok bought a three bedroom, split-level house in northeast Minneapolis for $198,000 using an 80/20 mortgage. That means that 80 percent is a standard fixed rate mortgage, and the other 20 percent is adjustable.

"The 20 (percent) is what's been increasing in cost over the last year for the most part," says Jennifer DeKok.

Jennifer says the adjustable portion of their mortgage has been creeping up since they signed up for the loan in 2003. She says in June 2004, the adjustable rate portion of the mortgage cost them $166 per month. Now it's up to $300 per month.

"It's not a big deal until you start thinking about interest rates keeping increasing, and then all of a sudden a payment that was less than $200 a month could suddenly be $500 a month," she says. "And then it becomes a very big deal."

The DeKoks try to keep to their monthly expenses in order. Like many Minnesotans facing rising energy costs, they enrolled in the budget plans offered by their gas and electric suppliers. But they say the instability of their adjustable rate mortgage makes it hard to follow their budget. And they're getting rid of it.

"We probably would never get an adjustable rate mortgage again," she says.

The DeKoks may not be snowed under because of their adjustable rate mortgage. But for other homeowners, rising interest rates make it hard for them to keep up with other debts like credit cards and home equity loans.

"Unfortunately it's a problem that's only going to get worse," says Chris Cagle, a credit counselor with Auriton Solutions in Roseville.

Auriton Solutions is a HUD-certified credit counseling agency, which means some of their clientele are referrals who are facing foreclosure.

"Obviously interest rates have been continuing to go up," says Cagle. "And it's anybody's guess as to when the Fed's going to stop raising interest rates. Every time interest rates go up, mortgage payments typically go up too."

Cagle says he's seen an increase in the number of clients who have adjustable rate mortgages. But he says usually it's not just the mortgage that is the problem. Cagle's clients frequently have high credit card debt as well.

He says sometimes clients with high credit card debt and an adjustable rate mortgage are living above their means. For instance, Cagle says homebuyers may be sucked into buying a house they can't really afford because they can get a low interest rate -- for a while.

"And so then of course, the problem is that now we're coming to judgment day with interest rates going up a bit," Cagle says. "And people are finding themselves unable to afford not only the mortgage, but also the bills, car payments, credit cards. The whole nine yards."

Apparently the popularity of adjustable rate mortgages is declining. The Mortgage Brokers Association of America reports that applications for ARMs amounted to 30 percent of all applications, down from 31 percent the previous week.

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