Thursday, September 20, 2007

ARMs of mass destruction

I've been saying it for years, but realized I haven't officially recorded here my opinion on adjustable rate mortgages.

So here it is: ARMs were, are, and always will be evil. As in IED evil. Ticking timebombs.

I don't blame FIs for offering them - I blame borrowers for accepting them. Most families are on a fixed (or predictably steadily increasing) income. They put together a family budget which matches income to expenses. Why, then, enter into an extremely long-term contract (30 years) committing yourself to an unpredictable stream of housing payments? There is the very real risk that your family's biggest expense will increase without a corresponding increase in income. Therefore, the only available adjustment is to your other expenses (ie: your consumption level), which has a very direct impact on your overall standard of living, present and future. The fact that real estate is so illiquid makes the bind that much tighter; there's no short-term exit strategy should your non-housing expenses go up (or income go down) unexpectedly. You would, at that point, be faced with the choice of default (and loss of assets, including the house) or refinance at a higher rate, which again directly impacts your future standard of living.

Maybe it's just me, but the more I can lock down (stabilize) my expenses, the better I sleep at night.

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