High Risk Loans, part 2

Another aspect to "High Risk" loans is adjustable rate loans. Now, I am NOT a lender and I want to make this clear up front, I am not suggesting ANY type of loan to anyone. If you are considering a loan, be it a new home loan or a re-finance, please talk not only to a lender but to a financial advisor to determine the best type of loan for you. There, I said it!

Adjustable rate loans come in as many flavors as your favorite ice cream, each being some variation of another. The basis of an adjustable rate loan is to provide the consumer with a low introductory rate that keeps the payment low so one has a better chance to qualify for the higher loan amount. The loan has a period that rate stays stable then adjusts according to some pre-defined indicator at a time in the future. The rates and time frames are negotiable, to a degree, with the lender to suit your needs.

The obvious (well obvious to some) downside is that none of us has a crystal ball that will tell, with certainty what the economic indicators will be in 2, 3 or 5 years. This being said, it's a crap shoot as to what your new payment will be when the loan adjusts.

This can work in your favor! For example if you know you will be getting a raise in pay in the next year, or so, your can qualify now for a home that you will be able to afford in the future. If you are too optimistic, the adjustment in payment can come as a big surprise.

How can you use this type of loan to your benefit? First off, DO NOT BITE OFF MORE THAN YOU CAN CHEW! I'll bet you heard that when you were growing up. What do I mean by that? I mean, be realistic about what you are purchasing, if you don't think you can afford the "adjusted" payment, don't spend that much money unless you have a plan to deal with it. Let me give you an example; an investor finds a property that is undervalued for the market but is still is too high priced to have a positive cash flow. He may be able to purchase using an adjustable mortgage that cost him/her interest only for 5 years and adjusts to prevailing rate +1% beginning the 6th year. If the investors plan is to sell and upgrade his investment within 5 years (and he/she sticks to it) then the adjustment will never affect the loan!

How can the everyday homeowner use these? Think about setting up a savings plan where you put a pre determined amount of money away every month to assist you when the rate adjusts. Consider looking into doing a refinance prior to the adjust date (be careful here because if you have a "pre-payment" penalty there may be a high cost involved.) If you are going to move in a couple of years then, again, a rate that adjust a year after your planed move date will never affect you.

There you have it! Adjustable rate loans are just another tool to use. Like using a $50 screwdriver as a $10 hammer, it will work for a while but soon you won't have any tools to work with.

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Don