It’s tempting, and in fact popular, to think of the world of home loans as being largely uniform and packed with the same types of deals. Long-term loans, designed to cover the potentially tough cost of an entire home, that are designed to assist both families and individuals in closing on their dream property. It’s the American dream defined, and it’s the backbone of the nation’s lending industry.
However, there’s significantly more to the mortgage industry than just mortgages alone. With such a wide range of different types, forms, and structures to home loans, it’s tough to say that the industry isn’t well-rounded and versatile. There are fixed rate mortgages, adjustable rate mortgages, special rate mortgages for properties in some areas, and an entire range of loans for commercial property.
In fact, if any one word defines the home loan industry, it’s varied. There are many different options for homeowners, and would-be homeowners, in fact. While each has its own assortment of benefits, disadvantages, and risks, they’re all equally viable options. All grant people the ability to purchase a home, and all exist in order to offer value to both lenders and borrowers alike.
However, there’s one form of mortgage that’s amassed a great deal of press, both good and bad, over the last four years. It’s called the adjustable rate mortgage, and it’s believed by many to be the cause of our recent housing market meltdown. Built with lenders alone in mind, it’s a fairly one-sided type of loan, or at least it used to be during the boom years of the lending industry in the mid-2000s.
Adjustable rate mortgages differ from their fixed rate counterparts in the type and level of interest that’s applied to the loan over its lifetime. While a fixed rate mortgage keeps the same interest rate for the duration of the loan – often thirty years or longer – an adjustable rate mortgage changed as interest rates adjust, allowing the actual rate of interest on the loan to vary wildly from year to year.
This means that should interest rates increase overall, the interest rates on your mortgage are also going to increase, often to a level significantly higher than the loan’s original rate range. This is a major reason for the downfall of many homeowners that relied on adjustable rate mortgages – due to their limited insulation from rates increases, they were left unable to pay as the economy sunk.
The majority of adjustable rate mortgages aren’t adjustable from their issuing date, however. For the most part, the first two or three years of an adjustable rate mortgage are similar to a fixed rate home loan. Payments are calculated with interest in mind, as usual, yet the rate of interest that’s applied to the loan isn’t free-floating with the market – it’s fixed at a set level, and is unable to move around.
These loans are represented by a 3/27 or 4/26 type of structure, which explains the length of the two different repayment periods. The first – in the first example’s case, the 3 – is a three-year term that’s only subject to fixed rate repayments. During this period, the borrower will only pay the set rate of interest that’s been issued by their lender, and isn’t subject to any changes in loan interest rates.
For the rest of the loan, however – in this case, twenty-seven years – the borrower is subject to the forces of the market, and its effects on their interest rate. If interest rates rise on the whole, they’re going to have to spend significantly more money on their loan repayments than they would have to with a fixed rate mortgage. This can make an ARM a significant home expense over the long term.
It’s this adjustable and unpredictable nature that caught many borrowers off guard during the recent housing crisis and its after effects. Swayed by the growing value of property, many homeowners in the United States and a range of other countries opted to purchase adjustable rate mortgages, letting them purchase homes that were otherwise priced fairly far outside of their price ranges.
This was fueled by the assumption that owning property, regardless of overall market demand for it, would result in a significant boost in their income and overall positive returns for them. The results of this massive rush to purchase property – and the mortgage boom that came with it – are obvious, public, and well-known. It was a subsequent bust, and one that hurt the industry a great deal.
Today, adjustable rate mortgages are significantly less of a threat than they once were, however as they’re still floated against the market – which in turn, is floated against a currency – they’re not an incredibly dependent and reliable form of financing your home. If financial security is a concern, it is generally better to instead opt for a fixed rate home loan, which will have stable interest rates.
While risky and potentially expensive, adjustable rate mortgages are still used by many borrowers, both in the United States and internationally. However, with the right strategy, and of course, funds enough to manage their potentially swaying repayments, these mortgages can be a good idea. Just remember that they are a major risk, and don’t expect your fixed-rate interest years to last forever.