Many Americans are confused about the terms of their adjustable-rate home mortgages and underestimate the amount by which their loan payments could jump, according to a new study by Federal Reserve Board economists.
The study found that about 35 percent of people with adjustable-rate mortgages didn’t know how much the rate could increase at one time, and 41 percent weren’t sure of the maximum rate they could face. About 28 percent didn’t know which index of interest rates would be used to determine their adjustments; many others gave incorrect answers, such as the consumer price index or “the going rate.”
The study, by Fed economists Brian Bucks and Karen Pence, says people with low incomes and less education are more likely to be unsure of the terms of their mortgages.
Most Americans still finance their homes with fixed-rate mortgages, which are simpler to understand and shield borrowers from the risks of surges in interest rates. But adjustable-rate mortgages have been popular in recent years, largely because they offered low initial payments, helping some people buy homes that otherwise might have been out of reach.
Adjustable-rate loans, also known as ARMs, accounted for about a third of mortgages granted in 2004 and 2005, up from an average of about one-quarter in the 1990s, according to the Mortgage Bankers Association, a trade group based in Washington. In recent months, however, the rise of short-term rates has greatly reduced the attraction of ARMs, and more borrowers are choosing or switching to fixed-rate loans.
Many of the ARMs granted in recent years carry a fixed interest rate for an initial period, which typically ranges from two to 10 years. A large share of such loans also allow borrowers to pay only the interest at first, leaving principal payments for later.
Borrowers who take such loans often don’t fully understand the risks of eventual leaps in their monthly payments, says Stella Adams, executive director of the North Carolina Fair Housing Center, a nonprofit group that helps low-income people with housing problems.
“What they’re told (by loan officers and brokers) is, ‘Don’t worry about it because you can refinance before the adjustment hits,’ “ Ms. Adams says. But that isn’t always possible for borrowers with heavy debt loads and little equity in their homes. Part of the problem, she says, is that borrowers are too trusting: “Consumers think that if the broker says I can afford this, (then) I can afford this.”
Another problem is that borrowers often choose their loans largely based on the initial monthly payments rather than carefully studying which loan would be in their best long-term interests.
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