Understanding sneaky mortgage clauses: Adjustable rate mortgages
Posted on May 23, 2007
Filed Under Mortgages
Buying a home for the first time is already stressful enough. By the time you have found your dream home and gone through the offer, counter-offer, acceptance, inspection, loan approval and final walk through, you just want the process to be done. You just want to move into your new home and relax.
The first time that you go to sign the loan documents it can be overwhelming. This isn’t aided by the fact that the title schedules a bunch of closings a day so they try to get you in and out as quickly as possible. With all that pressure, many buyers do not read their loan documents. I’ve heard them muffle, “Uh-oh he’s a reader.” which means that they will be there a while. It is YOUR money, you take as much time and ask as many questions as you want. Who cares if it takes you 3 hours to sign them all. You will be the person regretting it years later if you sign something you don’t understand.
What I would specifically like to address in this is how Adjustable Rate Mortgages are worded quite intelligently (for the mortgage company). Take a look at the text below on an adjustable mortgage. Let’s pretend that your interest rate is 6% right now, how high can the mortgage adjust to during the first adjustment? (click image to enlarge if you can’t read it)
The answer is 12%.
If you read it quickly, you’d think that the cap for each adjustment is 2%. Many homeowners end up expecting their mortgage to go from 6% to 8%. Come time for the first adjustment and they get their new statement with a 10,11 or 12% rate!
When you take time to read it again more carefully, it says that “the interest rate I am required to pay at the first Change Date will not be greater then 12% or less than 2.25%.” It says nothing about a 2% adjustment cap! Only “Thereafter, my interest rate with never be increased or decrease… by more than 2%.” So the first adjustment is not capped, but subsequent ones are. What good is that 2% limit once your mortgage hits 12%? It’s good for the mortgage company because now your rate can only drop by a maximum of 2%. This means that the earliest it will take for your loan to come back down to 6% is 3 years! What a great deal.
Here is an example of a mortgage that has a first adjustment cap. This mortgage has an initial rate of 9.00%. It’s adjustment cap on the first Change Date is 0.75%. It’s just written differently using 9.75% and 8.25% as the limits instead of say it’s 0.75%. Thereafter, it has a 1.5% adjustment cap for its lifetime.
Bottom line, read your documents carefully. Take your time at the signing table!
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Another observation: now is a great time to avoid ARMs and go with a fixed rate mortgage, especially for long-term buy-and-hold investors. Rates are at the basement low’s of ‘03 and ‘04, but by historical standards they’re still pretty darn low, and the spread between ARMs and fixed rates doesn’t really make the additional risk particularly attractive, in my book.