When one is tight financially, every penny counts. When it came to having options to keep the monthly payments low, many homeowners fell for it. The banks were eager to give out as many loans as they could without even making sure if the money they were lending was could even be paid back by the borrowers or not.
How did they do it? Well they used different forms of the adjustable rates mortgages to lure customers.
An adjustable rate mortgage or ARM as it is commonly called, is a good deal if you are financially disciplined and if you are comfortable after knowing what you are getting into. ARMs that have the initial low rate for a certain number of years and having predefined rate increases after the initial period can often be used to ones advantage because you are aware of the maximum amounts you would be paying at any time.
However there is an adjustable rate mortgage form called the interest only loan. In this you pay just the interest for the initial 5 years or whatever that initial period is. After the initial period one is required to pay an increased interest rate, that is not predefined, plus the mortgage principal. Since the principal was not paid for the initial duration of the mortgage, the mortgage monthly payment is much higher. This drastic jump in the payment comes as a shock that most families cannot absorb financially.
The sudden increase in the monthly payments ruins the family budget. Defaulting on the mortgage payments then is common which in turns ruins the credit history making it very difficult to even refinance.
Since future cannot be predicted, as happened with most homeowners in 2008 and 2009, a loss of job in the future when the mortgage payment is very high, often ends up in foreclosures and bankruptcy filings. The collapse of the economy was contributed largely due to the homeowners defaulting on the payments.
Another factor that one should consider for interest only loans is the fall of the home prices. Since no principal is paid off with the interest only loans one would have a debt that is more than the value of the home. Thus situation can make the refinancing of the home very difficult.
If you are “under water” now – having the remaining mortgage that is more than the value of your home, you should contact a bank to modify your mortgage. The Obama administration has created some options where people under water can refinance and get their financial lives back on track.
