Daily Blog

The good news about SubPrime loans is that they allow those with less than perfect credit to buy or refinance a home.  Since the pricing of loans is risk-based(See FICO scores tab) and SubPrime are riskier loans to make, investors(Wall Street) demand a higher return so the interest rates are higher.  The worse your credit, the higher the rates.  The conundrum here is those who can least afford higher rates are charged higher rates since they are higher risk. And those who could best afford higher rates are given the best rates because they are the lowest risk.  From Wall Street's perspective it makes plenty of sense, from the borrower's, not-so-much. 

Banks who issue credit cards do similar nonsense.  If you're one day late with your payment(an event that has no impact on your credit score as you need to be 30 days late to get a "ding") they charge you a $30. late fee and jack your interest rate up to the default rate(near 30%).  Now if you are having trouble making your payment at 14%, how does hitting you with a fee and raising your rate up to 30% help you out?  It doesn't. It's predatory lending at its ugliest and hopefully the current Congressional hearings will  bring about some much needed reform.

But lending has always been about the Golden Rule--he who has the gold, makes the rules.

Why do banks love ARMS? 

Because it shifts interest rate risk to the borrower. Their margin(profit) remains constant no matter what.

So when should you consider an ARM?

1. When rates have or are close to peaking.  That way you can ride then  down. You may wish to refinance to a fixed when you believe rates have bottomed for this cycle.  Of course all of this depends on how long you expect to keep the mortgage(or property).

or

2. When you expect to have additional income going forward and can meet the call of rising interest rates & payments.

or

3.  You plan on holding the property for a short enough period time that you can absorb any and all bad news and still come out ahead.

When should you never take an ARM?

When its the only way to qualify for the loan, you expect rates to rise and your income will not be increasing enough to handle the higher payments. If you fall into this category, your title will someday change from owner to renter.