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Posted 03.31.06

More Low-Income Borrowers Choose Adjustable Rate Mortgages, Creating Investment Risk For Many

MU Researcher Finds Characteristics of People with ARMS shifted dramatically

COLUMBIA, Mo. -- Despite higher house prices, low mortgage rates are driving more people into home ownership. A new study by a University of Missouri-Columbia researcher shows that the characteristics of people choosing adjustable rate mortgages (ARMS) have shifted dramatically, and not for the better. According to the study, more ARMS are going to people in the lowest income categories, the people who are least able to afford the investment risk.

Mike Finke.An ARM allows a household to take a greater financial risk by offering a lower than usual interest rate at the beginning of the loan. There is some potential that the risk will pay off in lower payments over the life of the loan. However, interest rates could rise significantly and borrowers could end up with much higher monthly payments.

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Financial Counseling and Planning

"As housing prices increase, there is more pressure to use ARMS to be able to afford a home," said Michael Finke, assistant professor of personal financial planning in MU's College of Human Environmental Sciences. "If borrowers are not aware that they are bearing a greater risk then they may make that choice and it could have harmful consequences in the long run."

According to the study, 10 years ago, most borrowers choosing ARMS were in the higher income brackets and could most easily bear the risk. For example, in 1992, 40 percent of the borrowers who obtained ARMS were in the wealthiest class while 25 percent had below average income. In 2001, ARM recipients almost switched positions with 26 percent being in the wealthiest class while 42 percent were considered low income.

"Between 1989 and 2001, the proportion of those who obtained an ARM and also had been turned down for other credit increased by 43 percent," Finke said.

These trends were not seen when fixed rate mortgages were studied. The number of people under the age of 35 getting ARMS increased significantly, but that trend did not repeat in the fixed rate mortgages, Finke said.

"If borrowers are aware of the risk up front then there is no problem," Finke said. "However, if borrowers are not aware that they are bearing greater risk and don't have flexibility in their budget they are not ideal candidates for an ARM."

The study was published in Financial Counseling and Planning, the journal of the Association for Financial Counseling and Planning Education.



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