Your Banker Offers You an ARM. Now what?

In the past several weeks I've helped more than my fair share of physician families navigate the waters of utlra-jumbo construction loans amid the crisis surrounding the subprime implosion. I've decided to coin a term here and call this phenomenon The ARMs Race. The ARMs Race begins when you, the head of your family, decide it's time you built your dream home. Whether it's a castle on the hill or a cottage on the sand, one thing's for certain: when it's all said and done, the price tag will be more than a million dollars.

So you make a trip to the banker, and that's where the trouble begins.

You want the lowest rate, naturally, and you want the lowest cost to originate the loan. The banker, to keep you from shopping elsewhere, naturally obliges with a low cost loan, and often it's a "5 and 1 ARM" or adjustable rate mortgage.

"An ARM?", you say with alarm. And with a consoling look the banker says confidently, "Why yes, an ARM. Look, it's inexpensive, and once your house is finished, you can refinance into a long term, fixed rate mortgage." You know, the kind of mortgage your mother told you to get.

So you get the ARM... because it's cheap, low cost, and it kept you from shopping elsewhere. And The ARMs Race begins.

If life happens according to the banker's prognostication, all is well. You get your ARM, you build your house, you refinance after it's all done, and walk away happy. The ARMs Race ends well.

BUT only IF things go according to the predictions.

When the rates begin to rise, as they did recently, then you may well be stuck with the ARM for as long as two years (because many have a prepayment penalty), or longer if you forget about it and wake up five years later when the first interest rate reset happens, in which case you get a huge increase in your monthly payment.

The ARMs Race intensifies as you realize (about a year or two after you get the loan) that rates have risen, and now if you want to refinance into a fixed rate loan, your rate will be even higher than it was when you got the ARM in the first place. When you add a 1% origination fee to the new loan (about $10 grand), the pain is intense.

And finally, if you continue with your ARM during a time when rates have risen dramatically, you may find yourself in The Day After. Here, you can no longer afford your mortgage, and you decide to sell your house.

But you find yourself in an interesting situation. You own a house that you - a doctor - cannot afford, trying to sell a seven figure home in an environment where most people cannot get a loan. Which means you may need to cut the price. But you probably lad little or no equity in the house to begin with, so you might actually be forced to write a check to get rid of it. Ugh.

So what can you do? Stay tuned. I'll bail you out in my next post.