It Has Begun - It Will All Hit The Fan In 2007, Part 11

The Wall Street Journal recently ran an article entitled “Strapped Homeowners Start To Feel the Pain of Rising Rates”.

It talks about how people who bought homes using Adjustable Rate Mortgages (ARMs) are starting to feel the pressure as rising interest rates drive up their payments, often by dramatic amounts.

In the article, it tells the story of Luisa Cordova-Holmes, from Detroit:

Luisa Cordova-Holmes was looking to lower her monthly payments when she refinanced her $312,000 mortgage in 2004. Instead, she wound up digging herself into a ditch.

For their new loan, Ms. Cordova-Holmes and her husband chose a so-called option adjustable-rate mortgage, which carried an introductory rate of 2.35% and gave her multiple payment choices each month. "I had a lot of financial obligations," says Ms. Cordova-Holmes, an accountant who lives near Detroit.

Two years later, however, the interest rate on her loan has jumped to 8.75%, her loan balance has climbed to $324,000 and her minimum monthly payment has risen to $2,257. She says the terms of the loan weren't clearly spelled out.

Ms. Cordova-Holmes says she would like to refinance, but can't -- in part because her loan carries a prepayment penalty that would force her to shell out thousands of dollars if she did. Instead, she's trying to sell her home. But with Detroit's economy slumping, she hasn't been able to find a buyer. When she and her husband first put the house on the market last summer, they were asking nearly $400,000. Now they're willing to accept as little as $270,000.

"We're in a very bad situation," she says. "The payments are just killing us."

The article doesn’t specify Mrs. Cordova-Holmes’ introductory payments, but using a mortgage calculator, it works out to $1,209 a month ($312,000 at 2.35%, amortized over 30 years).

According to the article, her monthly payment has gone from $1,228 to $2,257!

But wait, they said “her loan balance has climbed to $324,000 and her minimum monthly payment has risen to $2,257.”

If I use the same mortgage calculator ($325,000 at 8.75%, amortized over 30 years), I get a payment of $2,557.

Why the discrepancy?

That’s because $2,257 is her minimum payment. Note that her mortgage balance has increased from $312,000 to $324,000. Mrs. Cordova-Holmes has taken out an “option ARM”, where she can choose how much to pay each month. Her payment can actually be less that the accrued interest for that month. The unpaid interest is added to the principal of the loan and her mortgage balance increases.

According to the article, Mrs. Cordova-Holmes “says the terms of the loan weren't clearly spelled out.”

Here’s the scary part, Mrs. Cordova-Holmes is an ACCOUNTANT.

You'd think she would have some knowledge of how loans work.

I don’t think I’ll be asking her to do my taxes anytime soon…


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Links to previous "It Will All Hit The Fan in 2007" posts:
Part 1, Part 2, Part 3, Part 4, Part 4 (Addendum), Part 5, Part 6, Part 7, Part 8, Part 9, Part 10

(Original link to this post: http://thephantomrepublican.blogspot.com/2006/08/it-has-begun-it-will-all-hit-fan-in_20.html)