Major red flag of adjustable real estate loans

Adjustable-rate mortgages (ARMs) are becoming increasingly popular with borrowers, and the cost of borrower ignorance about ARMs is growing with it. Every day I encounter misperceptions that have led to bad decisions, or are about to.

To avoid getting trapped into a bad ARM, it is very useful to understand the difference between the interest rate and the fully indexed rate (FIR).

The ARM interest rate is the rate you see: it is the rate quoted by the loan provider, and the rate shown in the media. It is the same as the rate on a fixed-rate mortgage, with one difference. The ARM rate holds only for a specified initial period. That period can be as short as a month, and as long as 10 years. At the end of that period, the rate is adjusted.

The FIR is the rate you don't see. It is never quoted, never shown in the media, and is not a required disclosure. Yet it is the major indicator of what will happen to the rate at the end of the initial rate period.

If the initial rate period is long and the borrower expects confidently to be out of the house before it is over, the FIR is unimportant. But if the initial rate period is short, or if there is a reasonable probability the borrower will still have the mortgage when it ends, the FIR is critically important to the borrower.

The flexible-payment, or "option" ARM, which has been growing in popularity, has an initial rate period of one month. It is a favorite instrument of hucksters because they can advertise rates as low as 1 percent. They don't bother to mention that this rate holds only for the first month. The FIR, which provides the best clue as to what the rate may be in the 359 months that follow, is seldom volunteered.

Read the entire Inman News article by Jack Guttentag