As foreclosures continue to rise across the nation, President George W. Bush passed the Housing and Recovery Act on Wednesday to protect some homeowners expected to default on loans.
The decision comes months after Capital Hill began working on a package that was expected to relieve 1.5 million homeowners tied into risky adjustable-rate mortgages. Now, a reported 400,000 households are expected to benefit from the President Bush’s decision to help owners refinance from the risky ARMs for traditional 30-year loans.
Confused about the difference? You are not alone. Here are the key differences between the two mortgages.
An adjustable-rate mortgage is a home loan that’s typically paid out over 30 years. The interest rate on the loan, which is determined by the market or the lender, can vary based on terms of the loan. The adjustments take place over set period of time, depending on the type you have, such as 1-year ARMs or 5-year ARMs. The rate can increase or decrease over time.
On the other hand, a traditional mortgage, also known as a fixed-rate mortgage, charges one locked-in rate each year. It’s preferable for some because there is stability.
Over time, an adjustable-mortgage rate became an affordable tool for homeowners looking to purchase a home. It became an alternative to some that could not afford a traditional 30 year mortgage.
You see, with an ARM the interest rate can increase over the lifetime of a loan, and depending on the type of loan, could vary drastically from the starting interest amount. This is a huge difference from a traditional loan that offers a fixed rate throughout its lifetime. Homeowners looking to partake in purchasing during the rise in real estate would oft-times seek out ARMs.
Then came abusive or predatory lending, which bound some home owners to real estate they couldn’t afford. The initial terms were considered misleading by some. Establishing a low interest rate for the first two years with, for example, a 2/28 “exploding” ARM, some were surprised by the variables that determined the interest rate for the preceding years. Exploding indeed. The following years the interest rates could be determined by a volatile index rate and could also tack on additional 2-3 basis points, depend on the lender.
After the real estate bubble popped, many went into a financial tailspin as interest rates increased, causing a rise in mortgage payments, and income levels failed to match their rising expenses.
“Analysts estimate that more than five million households or about 10 percent of all homes with a mortgage, now owe more than house is worth, and the number is expected to grow as home prices fall,” wrote the New York Times.
Make no mistakes. Finances are not always the reason for securing an adjustable-rate mortgage and an ARM is not equal to predatory lending. A home purchase might not equate to permanent housing, for some, and to clamp down on low interest rates, homeowners sought ARMs as an option for temporary living. Now, due to the subprime mess, the opportunity to take advantage of adjustable-interest rates has declined, and not necessarily for lacking of trying.
In addition to refinancing risky mortgages, Fannie Mae and Freddie Mac, which have been heavily impacted by the mortgage debacle, may experience some relief from the Treasury Department with the new law in place.
And, for home buyers, there is a refundable tax credit equal to 10% of the purchase price of the home (up to $7500), and a real property tax deduction, according to Raffaele Mari, a CPA for the Tax Consulting Group based in Newport Beach, California. For a slowed sector, the law’s tax advantages may spur home sales. “They’re trying to provide some incentives for help in the housing area,” says Mari.