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Dear Pete,
I’m pretty sure we made a pretty big mistake back in the fall of 2019. We were house shopping and fell in love with a house way out of our price range. However, our mortgage broker said we could afford it if we used an adjustable rate mortgage. We received a 3% interest rate for three years and coming this November that rate moves to 7.5%. That means our principle and interest payment will move from about $2,100 every month to about $3,500 every month. There’s no way we can afford this. Our income has gone up, but that increase has been negated by inflation. What do we do?
—Lauren, McCordsville
I’m so sorry you’ve found yourself in this financial conundrum. There’s no doubt it’s incredibly stressful, and it’s possibly one of the biggest cases of financial strife you will ever face. My hope is, I can help you understand what’s to come, so you can make the best long-term decision for your family.
Sadly, you are correct. You made a very big mistake.
Based on the numbers you provided, I’m guessing your initial loan was in the $500,000 range. So that you could afford your monthly payment, your mortgage broker got you into an adjustable-rate product. Generally speaking, people choose an ARM when they believe their income will increase significantly in a short time, they don’t plan to stay in the property long, or they think interest rates are going to stay the same or decrease. To me, it sounds like your decision was based on a belief that mortgage rates would stay the same or decrease.
Using an ARM to finance a home is always a risky bet. It’s an especially risky bet if you got one when interest rates were at a ridiculously low 3%. It could have been argued that interest rates had nowhere to go but up. And they did.
Now, as to what to do. You have two primary options: Refinance to a fixed rate mortgage or move. By all means, deeply explore refinancing your mortgage to a fixed rate that you can permanently afford. But if you’re being honest with yourself, it’s unlikely this will work. In October 2019, 30-year fixed rate mortgages were about 3.75%. That’s why you chose the 3/1 ARM at 3%. Because you couldn’t afford a $2,300 principal and interest payment. Depending on what rate you get, you might be able to refinance to reset your principal and interest payment to about $2,800 per month or so. And while that seems like a better option than moving, it’s not. You would simply be taking a home you couldn’t afford and making it even more unaffordable.
I’ve witnessed thousands of financial mistakes firsthand, and anecdotally, the vast majority of them revolved around a poor housing decision. To take that a step further, the ugliest mistakes have come when a person tries to “fix” an initial housing mistake with another housing mistake.
I think you should move. This is not a popular answer, but it’s the right answer. By my calculations, you’ve paid down your mortgage by roughly $33,000 and your property value has increased significantly. It’s not out of the question that your home increased in value as much as 33%.
All of this math tells me it’s possible you’ve built about $200,000 in equity in the last three years. Take that $200,000 in equity, plus whatever equity you started with, and start over. If a $2,100 principal and interest payment is affordable, you can afford to borrow about $300,000 on a 30-year fixed-rate mortgage.
All of this would have been prevented back in 2019 had you simply borrowed $50,000 less and accepted a 30-year fixed-rate mortgage at 3.75%. That’s painful to think about now, but it’s the truth.
One last note: If you had to manipulate the type of mortgage you selected in order to afford your home back in 2019, I get the gut feeling your emergency fund isn’t where you’d like it to be. That’s just a hunch. But if that hunch is correct, you don’t have a ton of runway to solve this problem. You need to act rather quickly. Otherwise, you’re going backward by about $1,400 per month. You said it yourself: Inflation has been ugly, and whatever cushion you’ve had in your budget over the last few years has likely been engulfed by inflation.•
__________
Dunn is CEO of Your Money Line powered by Pete the Planner, an employee-benefit organization focused on solving employees’ financial challenges.
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That’s a painful lesson!
High Risk “ARM” loans are always a bet that interest rate drops or your credit/income drastically improves… sometimes you lose that bet.
Any broker suggesting an ARM in 2019 may not be a “crook” but they’re more than a little shady – that an awful year to suggest an ARM… especially if this was not very clearly explained.
The right time to refinance would have been a year ago when it was completely obvious what was about to happen. It’s way too late now… rates may not drop back to 4-5% again for many years.
Weirdly, right now is a decent time to consider an ARM – but again, they’re terribly risky – you have to be willing to lose, and potentially lose big.