A Time and Place for Adjustable Rate Mortgage

Posted Under: Personal Finance

Adjustable rate mortgage (ARM) is a taboo term by now, while the mess in the subprime loan market continues to unfold.

ARM is another financial tool with a purpose for its existence. However, buyers abused it to buy a house they cannot afford, and banks abused it to get unsubstantiated numbers on their balance sheet. We can generalize that bad outcomes in human society is always the result of an abuse of certain power.

ARM is a good option for someone who wants to buy a house in short-term. It allows the buyer to keep more money in the pocket for the period of time with the initial interest rate, while he invests those money in other places for a higher return. There are also various types of ARM to “tweak” the amount of payment. The usual scenario is for the buyer to live in the house for however long before the interest rate reset and then sell it.

Essentially, the buyer must understand that by taking an ARM, he is speculating on an appreciating housing market. If he plans to live beyond the expiration of the initial interest rate, he’s betting on a reset to lower percentage for the interest rate. The ideal scenario is either selling the house before the reset at an appreciated price, or staying in the house with a reset to a lower percentage. It’s neither the case for the people with ARM, which brings us to the current situation.

I wonder if the ARM buyers in default or facing foreclosure thought and understood about ARM when they took the loan. I doubt it though. They were too busy marveling at the house that’s too big for them to afford. I also wonder if the banks made sure that buyers understand ARM. I doubt that too. They were too busy adding all the numbers on their quarterly reports.

But then, perhaps ARM will be a good option for me in the next few years?

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