Adjustable Rate Mortgages

Adjustable Rate Mortgages (ARMs) have a bad reputation these days. During the recent housing boom, the promise of low monthly payments offered by many ARMs, at least initially, enticed many people into obtaining ARMs to finance their homes. For many consumers, the low initial payments promised by ARMs proved too good to be true, as the “initial interest rate” (the interest rate paid at the beginning of an ARM) period came to a close for many consumers and interest rates in the broader economy shot up.

To better understand the potential problems with ARMs, it helps to contrast them with fixed-rate mortgages. A fixed-rate mortgage is one in which the payments remain constant over a fixed period of time (often 30 years). ARMs, like their title suggests, do not remain fixed – the interest rates on ARMs adjust after a certain period of time –and this is where the pitfall lies for ARM holders.

For homebuyers and owners, the devil is in the details of the ARM. Some have longer periods of fixed payments (called the “adjustment period”) before their interest rates change. ARM interest rates are usually pegged to various economic indexes, so the rates will not always rise and may even drop, depending on economic conditions. Some economic indexes are more stable over time than others. However, recent years have seen a perfect storm of declining economy and ending adjustment periods that have combined to create volatile interest rates leading to skyrocketing mortgage payments.

The implications of ARMs for family law are significant. Often, one party is awarded real property, generally a home, that is subject to a mortgage. It is important for the party assuming the home to know if they have an ARM or a fixed-rate mortgage because the interest rates could rise at the end of the adjustment period and a party must be prepared financially to absorb the future increased payment. Given the prevalence of ARMs in recent years, a careful review of mortgage documents is in order for anyone thinking of assuming a mortgage liability.