Tuesday, April 24, 2007

Don't let your ARM break you

See that adjustable-rate mortgage pain coming and plan accordingly

By Jennifer Openshaw
Last Update: 7:49 PM ET Apr 24, 2007

LOS ANGELES (MarketWatch) -- You went a little large with that 2005 home purchase. It felt good. You bit off a lot in the form of a large adjustable-rate mortgage to get there, but you made it happen. The low 3.75% intro rate really helped. You knew it would eventually go higher, but hey -- home prices would go higher, and so would your income.

The problem is, it didn't happen.

Well, your income did rise, but so did your expenses: higher energy costs, growing family, rising taxes. Now about those home prices -- you know the rest of that story. See how home prices are flagging.

Now what? The honeymoon is about to end, and you're bracing yourself and your family for the inevitable. Your mortgage payment is about to go up, maybe by hundreds of dollars. And now is not a good time to join the stampede of foreclosures, preforeclosures, short sales and other forms of dire and unintended consequences.

What do you do?

Coverage of home buying and selling, housing prices, mortgage information and home improvement.

Panic? Probably not. Sure, it's a financial setback to see any cost go up a lot. But the secret to weathering any storm is to see it coming -- and plan accordingly. A lot of energy has recently gone into helping underwater homeowners avoid or deal with impending foreclosures.

Foreclosures? I'm guessing many of you will feel the pain or rising payments, but aren't in foreclosure land. You're not a subprime borrower. With a little planning and some modest sacrifices, you'll get over the hump. Here's how:

Know where you stand

The first step is to pick up the phone (or go in person) to your lender for exact figures. How big is the adjustment, when is it coming, and what will the next one be? Don't be reluctant. Human nature tells us to stick our heads in the sand when something bad happens financially. But know that lenders want you to plan and may even help.

Also, understand the full impact. Worst case, you might be looking at an extra $500 in interest payments after the reset. But for most it's tax deductible; the "net" impact is less.

If you plan far enough in advance, you may be able to save enough to get you over the hump. A $500/month adjustment is $6,000 a year. Not chump change, but not and an enormous sum, especially after tax effects are considered (in a 30% federal/state bracket, that $6,000 only costs you $4,200). If you could save enough to buy the home in the first place, you can probably save a good part of that $4,200 if you put your mind to it.

Find additional income sources

Obviously, if your costs go up, one solution to the problem is to expand your income. One way is to rent a room to a friend, relative, or insider. Not forever -- just until you can get your budget balanced again.

Or, find a small second job. Even a part-time retail job can pull $500 a month for about 15 hours a week. That goes a long way towards the reset, and you'll get a nice store discount besides (but don't spend it all!)

Refinance

I'm normally not a big advocate of bill consolidation loans, mainly because once smaller debts are wiped clean they have a way of reappearing. But consolidation can be a good way to offset a reset.

Why? Because reduced interest costs on credit-card and other high-cost debt can cancel out the increase in ARM interest, keeping your total interest costs relatively unchanged. This approach has risk, but makes sense with discipline.

The best idea, according to Eric Margolias, CEO of mortgage broker Source4HomeLoans, is to refinance into a fixed loan if at all possible. Fixed rates have stayed relatively constant, and with the ARM you remain exposed to rate increases. Prepare by fixing your credit, shopping at places like LendingTree.com and keep in mind that the percentage of fixed-rate applications being rejected is on the rise.

But for peace of mind -- and future financial prosperity -- "fixed" is probably where you should be anyway. Get there if you can.

Keep it in perspective

Margolias is adamant about looking at the bright side. Don't look at your ARM as a loan that got more expensive, but rather one that gave you a healthy discount in the beginning. You saved $6,000 a year initially on that $300,000 loan.

Tax implications aside, that's a big number -- where else can you get a discount large enough to buy a late model used car? It probably helped you get the home in the first place.

And finally, even if you don't successfully escape your ARM, history shows you're still in great shape. Two decades ago any mortgage under 10% seemed like a bargain. Today's interest rates -- even at the high end -- are among the lowest in history.

And that, as I see it, is the real bargain.

Jennifer Openshaw, author of the upcoming book, "The Millionaire Zone," is CEO of winningadvice.com. She is also host of ABC Radio's "Winning Advice with Jennifer Openshaw" and appears frequently on such shows as the CBS Early Show and Good Morning America. E-mail her at Openshaw@winningadvice.com.

Article courtesy of MarketWatch 04.24.07

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