At least I don't have an ARM

If I ever do a Master’s Thesis in Economics, this may very well be the topic: has access to credit driven up the price of homes?

It’s a subtle question, but the point is this: if we didn’t have banks to lend us lots of money in mortgages, would homes cost less? My guess is that yes, homes would cost far less if Banks did not lend us money. You might even be able to save up and buy a home outright if not for the access credit.

I’m also willing to bet that as banks find more ways to play fast and loose with credit, home prices increase. Why? Because I believe that credit really is part of the money supply, and the more money their is out there the more things start to cost. Money is infinite, but stuff is, at least in theory, finite. So money drives up costs.

Simplistic? Maybe, but close enough.

Which brings us to ARMs (adjustable rate mortgages). If you’re not familiar, ARMS are pegged to the Prime Rate (the rate at which the Government lends money) or some other fixed economic index. After the intro period runs out, when the ARMs usually have a low fixed rate, your interest rate becomes whatever you mortgage defines it as in your loan document. So it might be Prime plus 3%. So if the Prime Rate is 3% then you’re payin 6% on your mortgage.

Fine so long as the government is feeling loose with money, but if they tighten up and your rate goes up, then your monthly mortgage payments go up, too. Morningstar.com spelled it out in this article yesterday. They describe a $180K mortgage with a monthly payment of $808 at the teaser rate of 3.5% leaping to $1258/month when the ARM kicks in at the end of the intro period. It’s not a crazy scenario at all. My fixed rate mortgage is %6.25 and of course lots of ARMS are going to be higher than that as interest rates have been rising.

Morningstar says that since ARMs are a relatively new context, these introductory periods will be ending in big numbers soon. We’ll see what happens to the economy. Consumer spending could plummet and a lot of people could be screwed.

See, the trick of the ARMs is this: you become convinced that your income will increase over time and then you can refinance. Of course, refinancing comes with equity leeching costs of its own, but set that aside… what if you’re income doesn’t go up?

I’ve gone from job-to-job over the last few years and my income hasn’t really seriously increased. In fact, in many ways it’s been about the same or lower. I’d be pretty screwed if I’d gotten myself into an ARM. In fact, I even considered it at one point, and like every other fool out there I only looked at the initial rate. Mine was to be a five year ARM, so who takes seriously a dramatic increase in your costs five years from now.

But of course you should. Take my example above: not only did the person with the $180K house (a modest price in much of the country) see a $400 jump in their monthly expenses, that money is all rent. It’s pure profit for the bank. They aren’t paying any more of the loan at $1258/month than they were at $808/month. They are simply out more money.

So watch out what you get into and look out for your neighbors. You may find your neighborhood changing as these ARMs start kicking in.