ARM holders will soon see large interest rate increase

Rates due to adjust for those who took out risky hybrid loans

This is a tough time for American consumers. Gasoline prices are rising to record levels. Heating costs this past winter were higher than ever. And the lowest interest rates for home loans offered in decades were offered three or four years ago.

Most people can easily see why consumers should be concerned about gasoline prices, but why would anyone be affected by interest rates that were offered several years ago?

Because many buyers took out hybrid loans when interest rates were down near 5% in 2002-2004. Despite low rates that made locking in on a fixed-rate mortgage a smart thing to do, many buyers opted to “save” even more money by taking out a hybrid ARM. A hybrid ARM is a home loan that offers unusually low rates for the first three to five years. After that, the rate adjusts to whatever interest rates are current in the market. When interest rates hold steady, having a hybrid loan doesn’t matter much. The rates will simply adjust to whatever they have been, and that won’t be much. The option to “save” money at a time of low rates may not have been simply to keep the monthly payment artificially low; the price of housing in many parts of the country was already becoming unaffordable in many parts of the country, and taking out a loan with an artificially low interest rate might have been the only way that some borrowers were able to afford the houses they wanted to buy.

But rates have been steadily rising for the last few years. That means that when the 3-5 year periods of low rates expire, many homeowners will see increases of 3-5 points in their interest rates. This, for many people already burdened by high credit card debt and gasoline prices, could cause an increase in their house payments that will make the monthly mortgage difficult to pay. For those who took out hybrid loans with interest-only payments for the first few years, the sticker shock could be catastrophic.

The number of hybrid adjustable loans out in the current market is about 12%. It is not, by any means, a large percentage of all mortgages. But many of these loans were obtained by buyers who were purchasing in markets with ultra-expensive housing, such as California, or by buyers who had problem credit histories. This, lenders fear, could lead to a large upswing in the total number of home foreclosures. This does not bode well for a market that is already seeing a steady increase in the foreclosure of property as housing markets cool while interest rates rise.

The combination of gas prices at an all time high and huge increases in monthly mortgage payments could lead the country towards a recession, particularly if the war in the Middle East continues, leaving the price of oil subject to the whims of war.

It remains to be seen exactly what will happen, but during the next two years, millions of Americans will suddenly find themselves with a lot less money to spend each month.