If you're thinking about purchasing a home, you may have heard about the numerous advantages of "adjustable-rate mortgage" (ARM) loans. ARM loans are home loans that begin with a low interest rate in the interest of helping a homeowner afford their house. This interest rate is recalculated to go up over time, making the payments increase over time. Many homeowners begin this purchase with the idea that they will be able to increase their earning potential or refinance their loan after several years. But there are some common issues that can make this problematic.
1. Credit Scores
ARMs are often targeted towards sub-prime buyers as a way for them to purchase a property even though their credit scores are currently sub-optimal. Buyers hope that they will be able to improve their credit scores in the future and subsequently refinance at a lower interest rate. But things can happen; if a buyer isn't able to improve their credit score, they will not be able to refinance before the interest rates go up.
2. Earning Potential
Similarly, an ARM banks on the idea that the individual in question will be able to increase or maintain their earning potential. But if someone has lost their job or has downsized their lifestyle, they may not be able to refinance their ARM, and their home mortgage price is going to now exceed the amount they can pay.
3. Jumbo Loans
While most first-time home buyers can afford a conventional loan for a conventional house, an expensive home may require something known as a "jumbo mortgage." Jumbo mortgages are mortgages with costs that far exceed the average property value in an area. Most ARMs are for jumbo mortgages, and that creates a secondary issue: when you are refinancing, there are far fewer lenders who are willing to take on this type of loan. Thus, even if your credit and income has improved, lenders may not be available.
If a property has depreciated substantially, it isn't going to be able to be refinanced for the same amount. During the last housing crisis, homeowners frequently found themselves underwater with adjustable-rate mortgages with no way to refinance to better terms because they would need to pay the difference. Because of this, it's very important that buyers do their due diligence regarding the actual value of their property.
It's always important for a homeowner to look analytically at how much home they can truly afford. An ARM depends on the idea that a homeowner's financial or credit situation will have improved in the future—but there are no guarantees of this. Many homeowners have difficulty meeting their fixed-rate mortgage payments; even more will have issues meeting an ARM mortgage payment.