CONSUMER CAUTIONS

CONSUMER CAUTIONS


Discounts


Some lenders offer initial ARM rates that are lower than
the sum of the index and the margin. Such rates, called
discounted rates, are often combined with large initial loan
fees ("points") and with much higher interest rates after the
discount expires.

Very large discounts are often arranged by the seller. The
seller pays an amount to the lender so the lender can give you
a lower rate and lower payments early in the mortgage term.
This arrangement is referred to as a "seller buydown." The
seller may increase the sales price of the home to cover the
cost of the buydown.

A lender may use a low initial rate to decide whether to
approve your loan, based on your ability to afford it. You
should be careful to consider whether you will be able to
afford payments in later years when the discount expires and
the rate is adjusted.

Here is how a discount might work. Let's assume the
one-year ARM rate (index rate plus margin) is at 10%. But your
lender is offering an 8% rate for the first year. With the 8%
rate, your first year monthly payment would be $476.95.

But don't forget that with a discounted ARM, your low
initial payment will probably not remain low for long, and that
any savings during the discount period may be made up during
the life of the mortgage or be included in the price of the
house. In fact, if you buy a home using this kind of loan, you
run the risk of...


Payment Shock


Payment shock may occur if your mortgage payment rises
very sharply at the first adjustment. Let's see what happens in
the second year with your discounted 8% ARM.



As the example shows, even if the index rate stays the
same, your monthly payment would go up from $476.95 to $568.82
in the second year.

Suppose that the index rate increases 2% in one year and
the ARM rate rises to a level of 12%.



That's an increase of almost $200 in your monthly payment.
You can see what might happen if you choose an ARM impulsively
because of a low initial rate. You can protect yourself from
increases this big by looking for a mortgage with features,
described next, which may reduce this risk.