Misconception 3: It is a good idea to use an Adjustable Rate Mortgage (ARM) with lower rates or a balloon mortgage if you know you are going to be moving in a few years.
Ask all those people being foreclosed on how good these turned out for them when the real estate market fell and they couldn't sell their houses for less than they paid for them. That is because lenders hate to lose money and all of the risk has been transferred from the lender to the mortgage holder in these financial vehicles. Let me explain.
During most of the 1970s, fixed-mortgage rate ran in the range of seven or eight percent. But in the early 1980s, toward the end of the Carter administration, fixed-rate mortgages were as high as 17 percent and real estate sales dried up. The Lenders found themselves paying out 12 percent on CDs, but were only bringing in 7 percent on thousands of mortgages. So they invented the ARM tied to the prevailing market interest rates. That way, they make their money and you pick up the difference when the market rate goes up.
Now, that is a great if you are purchasing at a high-interest rate and it drops. It is a disaster if you buy one of these when rates are low and they start to rise. That is what has happened over the last decade. During the late 1990s, changes in federal government rules created new institutions like Fanny Mae and Freddy Mac along with various financial rule changes. There stated goal was to make home ownership more affordable for more people. It was a noble goal, but as with most things the government pokes their fingers in, it back-fired and ended up costing up plenty.
During the early 2000s, especially after the events of 9/11/2001, the economy when into a slight recession. The Fed decided to combat this by lowering the market interest rate several times. This certainly did create a feeding frenzy. Lenders could sell low-interest ARMs to people that would never qualify for a thirty-year fixed rate. Since more people could qualify for a loan, more houses were built to sell to them. Since more people wanted to buy houses than were available, the value of all real estate went up, while interest rates stayed low.
Speculators got into the market, buying properties and selling them for nice profit a year later. For over five years, the real estate market went crazy, but when financial situations are artificially created, they eventually fall apart. The interest rates started going up. People with those low-rate ARMs saw their mortgage payments go up until thousand of houses ended up in foreclosure. With no more cheap ARMs, thousands less people could qualify to buy houses. This combination created an over-supply of housing and the real estate prices plummeted and thousands more properties brought by speculators went into foreclosure.
This in turn caused a downturn in the entire economy, which started affecting those who had standard fixed-mortgages throwing even more people into economic troubles. It will take years for the economy to get out of this mess, especially since the government is trying to 'fix' a problem it helped create in the first place.
Now, I went through this highly abbreviated version of our recent economic woes to point out a couple of things. First, there will always be people who try to tinker with the economy in an attempt to profit themselves. Second, the only way to protect yourself is to not play the game and own your home one-hundred percent.