This One Decision Could Cost You Your Home

Sam and Laura Downey fell into the adjustable-rate mortgage (ARM) trap.

Back in 2002, Sam had just landed a great job with tons of upward mobility. And after a little math, it seemed like an ARM would be the best choice when buying their new home.

For the first seven years of the loan, the interest rate would be fixed at a nice low rate — low enough that they could afford a bigger home in a nicer neighborhood.

They knew that the interest rate could rise after that period. But at his current job, Sam was “guaranteed” a yearly wage increase as well a biannual bonus based on his sales.

“Even if the payments increased, we were sure we would be in a strong financial position in seven years,” says Laura. “And there was always a chance the rate would go down. It seemed like the actual risk involved was relatively low.”

Of course, that was before the housing bubble burst and America was plunged into the worst financial crisis since the Great Depression. In the following months, millions of Americans lost their jobs.

Sam was among them.

“I think our mortgage’s interest rates adjusted just a few weeks after Sam lost his job,” says Laura. “We were already struggling to pay the bills and then our mortgage payments increased by more than $1,000 a month.

“To make ends meet, we both had to work two jobs. It was a living hell. We barely saw each other and were tired and anxious all the time. Eventually, we managed to get back on our feet and refinance at a lower fixed rate. But we had gone through most of our savings by then.”

Sam and Laura’s story isn’t an uncommon one.

ARMs are predatory loans built to entice homeowners in with a low interest rate… but leave the window open for massive interest hikes later on.

Unlike a fixed-rate loan, the interest rate of an ARM changes based on market conditions. This way, the bank can transfer the risk of higher interest rates to you. And in return, they can offer you a lower interest rate upfront.

But take it from me. Accepting that risk isn’t worth the lower rate. Sam and Laura were lucky. It cost them most of their savings and they had to work two jobs, but they were able to save their home.

Millions of Americans weren’t so lucky. Because their homes were underwater (meaning the balance of their loan was higher than the value of their home). And the banks refused to refinance them.

In all, 10 million families were forced out of their homes.

So what’s the best alternative?

The short answer is to buy a home you know you can afford.

Ideally, this means buying your home with cash and taking on zero debt. For most folks, this goal is a little unrealistic.

But there’s an alternative that’s relatively safe compared with other loans — and it will minimize the overall interest you pay.

The Only Way to Finance a House

I’m talking about a 15-year fixed-rate mortgage.

Now, the interest rate on a fixed loan looks higher than that of an ARM loan. At least at first…

But your interest rate is going to stay the exact same throughout the duration of the loan.

This means you’ll be making the same payments every month, which makes it easier to plan and budget. And you won’t be subjected to any nasty hikes in interest when the market takes a turn for the worse.

Most folks opt for a 30-year loan because the monthly payments are lower. But if you go down this path, you’ll be shackling yourself to 30 years of debt and flushing thousands of dollars in interest down the toilet.

A 15-year loan might mean that you have to consider a smaller home. But in 15 years, you’ll be mortgage-free and thousands of dollars richer.

You can further reduce your monthly payments by making a 20% down payment on the loan. This allows you to forgo the private mortgage insurance payments that would otherwise be mandatory.

All the best,

Owen Sullivan
Editor, Money & Crisis

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