Archive | March 2013

Adjustable Rate Mortgages

As I’ve noted before, Yahoo News can hardly be considered a good source of quality information. Yet from time to time I browse through the articles to glance at the odd, the ridiculous, and the very occasional piece of good information.

Today, unfortunately, I stumbled upon something particularly bad in the second category: Jeff Brown is the author of the article “Why it might be time for home buyers to reconsider an ARM.” I’ve never felt compelled to call an individual out on something like this before, but the advice he gives here holds the potential to severely injure the financial stability of anyone who relies on it. It’s egregious and irresponsible.

First, what’s an adjustable rate mortgage? Also known as an ARM, an adjustable rate mortgage is a home loan that starts off low- even lower than the going rate for a fixed rate mortgage. Then, after a given period of years (which vary from loan to loan), the interest rate adjusts according to where rates are at that time.

Here are some of the supporting facts that Mr. Brown brings out in order to support his position, followed by the flaws that negate this line of thinking:

1. The current rate for a 5 year ARM is just 2.7% compared to 3.5% for a fixed rate mortgage.

  • Sure, that’s true as far as it goes. But interest rates are still down near historic lows, so once those adjustments start hitting you’ve really got nowhere to go but up. The market seems to finally be recovering, albeit slowly and cautiously, and if nothing too terrible occurs we may not be in that bad a place in 5 years…and 0.8% is a really thin buffer to be relying on in such circumstances, since good economies mean higher interest rates.

2. Annual and lifetime caps on interest rate increases mean that from the 2.7% you’ll never pay more than 8.7%, which isn’t too high by historical standards.

  • 8.7% might not be all that bad over the scope of history, but 3.5% is one of the better rates we’ve ever recorded. Why not go for the sure deal rather than risk “not especially high”?
  • That 6% maximum difference? It’s expensive. If you put 20% down on a $300,000 house and use that 2.7% ARM, you’ll pay $1,348.43 per month for five years. If the next several years after that raise your interest rate to the max, you may spend the rest of the life of the loan paying $2,254.52 per month. That’s an extra $906 every month adding up to an extra $10,873 per year!
  • By contrast, the 3.5% fixed rate will only increase your payment by $104 per month and you get the security of knowing it will never rise.

3. ARM rates are going to rise, so the time to buy is now so that the maximum rate your loan can rise to doesn’t get any higher than it would with today’s circumstances.

  • Lord, save us from terrible logic. Mr. Brown tells us to consider buying an adjustable rate mortgage because the rates will go up over the next few years… Why would you ever buy an ARM knowing that its rate will soon increase beyond what a fixed rate can get you right now? To do that is to literally volunteer to pay more money.

In the closing paragraphs of the article Mr. Brown gives a nod to most readers’ reality. He points out that ARMs are really only good for people who can pay the home off within or shortly after the fixed rate period of the loan or for people who intend to sell the home within the fixed rate period. Even then, I’ll throw a caution out: be aware of the housing market in your area. If you plan on selling a newly bought house sometime in the next three to five years, you may actually lose money because you didn’t have time to build up enough equity to cover closing costs, etc or even because the value of the home dropped in the short term. So if you won’t be there long, consider renting!

Perhaps I’ve been overly hard on Mr. Brown. But the facts are that, for the vast majority of homebuyers, an ARM will cost an arm, and maybe a leg too. In a society and publishing medium with such a short attention span, it’s my opinion that his qualifications should have been front and center, not hidden at the back.

People tend to think they have more money and discipline than they really do, and often spend too much when buying a home in the first place. The ignorant or inattentive reader runs a definite risk of hurting themselves by relying on the article’s information in the way it was presented, and I don’t like that. Frankly, given the current interest rates and economic conditions, the article wasn’t appropriate at all.

Now, to be fair, ARMs do have their place. If the situation was more or less the opposite of what it currently is, and interest rates were looking to drop on the long term, then an ARM might be valuable for its ability to follow rates down without a refinance. And Mr. Brown has a point as it comes to those who can (and will) pay their homes off early- you can save some money if you’re in that group. But odds are very high that you aren’t. If it were me, I’d get the fixed rate mortgage and suffer a little bit of extra interest while paying extra on the principal anyway and having a safety net against any future lapse of discipline on my part.

Any time you’re looking to buy a house, keep this goal in the forefront of your thoughts: What can I do in this situation to maximize my chances of keeping this house if something goes wrong?

Hope for the best while preparing for the worst and you might just avoid having the bank knock on your door someday.

 

Thanks for reading,

-Taylor

Retirement: A Horror Story

Wow. Two months can sure fly by fast. Sorry for taking so long to post again! I’m heading into the final weeks of my undergraduate education, so the future’s bright even if life has been all too crazy these past couple of months.

Now, on to the post:

Image from http://georgedelapaz.blogspot.com

Frankly, I’m a little frightened for our future.

Okay, so that’s a bit sensationalist. Let me explain: recently I happened to be reading a Yahoo news article (not a great source of news by any stretch of the imagination, but at least you can filter out the majority of the bullcrap) when I noticed a poll at the bottom of the article. The poll’s question was, “Are Social Security and Medicare crucial to your retirement security?” At that point in time, approximately 601,000 people had responded…and 78% of them said that yes, they’re crucial.

That’s kind of frightening, and if it doesn’t frighten you maybe it should. Social Security benefits are paid out of the Social Security Trust Fund, operated by the Social Security Administration. That, supposedly, has about $2.7 trillion in it, held in trust for the benefit of America’s seniors and disabled. Unfortunately, if the Social Security Trust Fund were a warehouse, it’d be pretty much empty aside from a sticky-note from the federal government labeled, “IOU” laying around somewhere on the floor.

The government can just pay it back when that becomes necessary, right? Sure- that is definitely a possibility. Unfortunately, the government is wallowing in $16+ trillion total debt (including this debt), is near its debt ceiling, hasn’t had a real budget since 2009, and has proven incapable of finding a solution to this problem for several years. So it might not be all that likely as possibilities go.

I could make a whole series of posts about why our current entitlements structure is unsustainable, but here I want to look at the other side of the coin: personal effort, planning, and saving. If you want to retire with dignity, it’s on you to make sure that happens. No one else cares about your retirement like you do. Not your company. Not your government. Not even your kids. America is known for having one of the most individualistic societies of the modern world. With that individualism comes a requirement to be self-reliant, because you cannot live your life the way you want to and still fit in a nice, neat little government-proscribed box.

From the above it’s pretty clear that the government’s not really in much position to help, aside from keeping you over the poverty line by a razor-thin margin…maybe. Personally, that’s not the picture I want to see of my future retirement. It’s time we started stepping up as individuals to look ahead, choose where we want the future to take us, and start pushing ahead in that direction. That’s life, really: the pursuit of goals and dreams of all shapes and sizes. It’s warm and uplifting, and even though storms still come it will always be better than the cold comfort of subsistence on government handouts.

Thanks for reading,

-Taylor