George Kamel - The Sneaky Mortgage Trap People Are Falling For

Episode Date: July 12, 2023

Today we're diving into the world of adjustable-rate mortgages. They may seem affordable at first, but let me tell you, they're always a bad idea. Buckle up, because we're about to uncover why they spell trouble. Links: Mortgage Calculator Ramsey Real Estate Hub I love a good deal, when you sign up using this link, I’ll hook you up with a 14-day free trial and $15 off your first year of the premium version of EveryDollar. Ramsey Solutions Privacy Policy Learn more about your ad choices. Visit megaphone.fm/adchoices

With arms wide open under sunlight. Welcome to this place. I'll show you everything. You need to know about adjustable rate mortgages and why it could leave you wide open to a whole lot of risk. What's up, guys? George Camel here. And if you're wondering why I'm singing Creed's 2000 hit with arms wide open, it's because today we're talking about arms,

a.k.a. adjustable rate mortgages. Now, if you got excited for a second, because you thought this whole episode was going to be about Creed, I'm sorry to disappoint you. No, you're not. You see, as interest rates have skyrocketed, more and more people are looking to arms to finance their home purchase.

In January of 2022, adjustable rate mortgages accounted for just over 3% of home loan applications. But that number jumped up to 10.8% just four months later. And I'm going to let the cat out of the bag right now. Adjustable rate mortgages are a bad idea. In fact, it's one of the most obvious,

clear-cut financial no-noes I can think of, right up there with buying a guitar on a credit card to start your own Creed cover band. Don't do it. So in today's video, we'll take a closer look at how arms work so you'll understand why they're a bad idea and we'll cover a smarter mortgage you should get instead. But first, move your arm just a little bit and click those like and subscribe buttons. And if you move it just a little further, you'll make it over to that share button.

And then I can stop asking the algorithm... Can you take me... Okay, so what exactly is an arm? Well, an adjustable rate mortgage is a home loan where the lender can change your interest rate. Usually, that means your rate goes up and up and up. So why would someone choose this? What makes an arm attractive? I mean, I know what makes these arms attractive,

but what makes these types of loans attractive? Well, an adjustable rate mortgage gives you a lower interest rate for an initial period, making your monthly payments more affordable at first. But after that initial period is up, things can get ugly fast. Like the Woman Tell All episode of The Bachelor, remember Cheney's clapback at Clayton in season 26? He thinks we're crazy, so stop. Just like that. You see, an arm has an interest rate that changes based on market conditions, which can lead

to higher monthly payments, creating some financial stress if rates go up or if your life circumstances change. Basically, the lenders, or as I like to call them, arms dealers. Use a lower initial interest rate to entice you into a loan that transfers the risk of higher rates off of them and onto you. Here's how it works. An arm has three main parts, the humorous, the radius, and the ulma. Sorry, I couldn't resist.

Okay, enough arm jokes. For now. But in all seriousness, an adjustment, an adjustment, The investable rate mortgage does have three basic parts. The initial interest rate, the introductory period, and the adjustment period. The initial interest rate is the interest rate your arm starts with. The introductory period is the amount of time that rate stays the same. And once that intro period is up, the adjustment period kicks in,

which is the time when your interest rates can go up or down. Now let's look at how these work together. When you take out an arm, the bank sets an initial interest rate. This might be slightly lower than a conventional mortgage rate. So right now, an arm might give you 6% instead of a 30-year fixed, which might be at 7%. That low rate stays locked in during the introductory period,

which could be anywhere from one to 10 years. But then, the honeymoon is over. Just like when you get back from the honeymoon and realize you married someone who loads the dishwasher like a raccoon on meth, the dishes go in a certain way. It's not that difficult. So once the introductory period is over,

you've now entered the adjustment period. Yeah, it's scary. Because now the lender can change your interest rate and your mortgage payment every year. Or with some loans, And this is the point where it can feel like that arm has slapped you in the face. And they'll keep raising your rate until they hit what's called the rate cap. A rate cap is a limit on how much the lender can change your interest rate.

So when you start wondering, can you take me higher? The answer is yes, up to the rate cap. The higher the rate cap, the higher your rate can go. It's that simple. Now there are different types of rate caps and caps on how many times lenders can change the rates. Does your brain hurt a little bit? I know. It's a lot. And if you think this all of your time,

all sounds complicated, buckle up Buttercup because there are different arm options and they all have numbers within their name. And those numbers represent the loans introductory period, adjustment period, and rate caps. And honestly, they're flat out confusing to most people, including Michael Scott. What kind of mortgages you get? Uh, 10 year? Well, 10 over 30, so 30 year total. What? What? And when you think about it, it makes complete sense for the banks. If borrowers think the details of an arm are too complicated for them to understand,

they're more likely to just do whatever the bank says. Now, here's an example. A 5-1 arm with 2-1-5 caps. Even just saying that out loud makes me want to completely check out, but I'm here for you, okay? Let's break down what this means, because when you know how these work, you can see why they're a bad idea.

So let's imagine John and Julie got the most popular adjustable rate mortgage, a 5-1 arm. The first number is the amount of years in the introductory period. The second number is the amount of years between rate changes. So a 5-1 is a loan with a 5-year

introductory period after which the interest rate can change once a year. Okay, that part not too tricky. But John and Julie still have some questions. How much can their lender increase their rate each year? How many times can the lender change their interest rate rate over the life of the loan? That's where those two-one-five rate caps come in. The rate caps are all about percentages. So here's what that means. The two means a 2% per year rate change in the first adjustment period. The 1 means a 1% rate change during any adjustment period after that. And the 5 means a 5% total adjustment above or below the initial interest rate. That's the rate cap. And lenders want you to think that those rate caps protect you, but that's not how it works. Look at what happens to John and

Julie's 30-year arm when they start at a 4.3% interest rate. Yeah, John and Julie's interest rate more than doubled. That's insane, especially when lenders issue fixed rate mortgages around 5% or 6%. And since lenders rarely lower adjustable mortgage rates, John and Julie could get stuck paying a crazy rate for 20 years. So why are more and more people choosing arms? Well, with high home prices and rising interest rates, a lot of people believe that the lower initial rate is the only way they're going to be able to afford home ownership. Plus, a lot of people think they can game the system. Well, I'll just get an arm with a low interest rate now, and then later, when rates go down, I'll refinance before my payments start to skyrocket. But guess what?

It costs a hefty chunk of change to refinance. And what if interest rates don't go down before that intro period is up. Now, unless you have some kind of magic eight ball for interest rates, your outlook not so good. Okay, sounds legit. So now that we know why arm are a bad idea, what kind of mortgage should you get? Well, the answer is simple. A 15-year fixed-rate mortgage. That's it. This means you agree to repay your home loan over 15 years,

with an interest rate that doesn't change. And here's why that's good. A 15-year mortgage gets you out of debt faster than a 30-year mortgage. Shocker. And it typically has a lower interest rate compared to longer-term loans. So not only do you pay the house off in half the time,

but you also save potentially six figures worth of interest payments compared to a 30-year loan. Six figures. That's probably enough money to pay for a private creed concert. Now keep in mind, a 15-year loan will have a higher monthly payment compared to a 30-year loan. That's just math. A shorter time frame for the same loan equals a bigger monthly payment. But remember, a higher payment means quicker payoff and less interest paid. So you win big in the long run. Don't believe me? Take a look at this.

Now to keep things fair in this example, each loan balance is $200,000 after the down payment, and it has an average interest rate from April 2022. We left out insurance, property taxes, and other fees so you can just look at the mortgage payment. Now, as you can see, arms start with a lower monthly payment, which is attractive, but they cost the most long term. And here's what that means. You paid $135,000 more for the same house compared to a 15-year fixed. On a $200,000 loan.

$135 grand on a $200,000 loan. That is insane. Not to mention, the monthly payment spikes by hundreds of dollars because of those changing interest rates. So now you see, those arms aren't so attractive after all. So trust me, a 15-year fixed-rate mortgage is the best bang for your buck, and it will give you more control of your money by shifting the risk of high interest rates back where it belongs, off of you and onto the lender.

So what's the takeaway here? Well, if you don't have a mortgage yet, stick to a 15-year fixed-rate mortgage when you're ready for it. How do you know when you're ready? Well, for starters, make sure you have no consumer debt and a fully funded emergency fund. Then you want to try to put at least 5% to 10% down and make sure that monthly payment is no more than 25% of your after-stance. tax income on that 15-year fixed. Now, if you already have a mortgage and it's an arm, do a break-even analysis to figure out when and if it's the right time to refinance to get out of that mess. And if you can't qualify for or afford a 15-year fixed rate conventional

mortgage, it's okay to put your house dreams on hold for now so you can focus on getting your finances in order. Get out of debt first, get an emergency fund in place, save up the down payment, and this will be a much more peaceful decision. If you want more helpful info on mortgages, check out the Ramsey Real Estate Hub that has tons of resources and tools to help you on this journey of home ownership. And if you're in the market for a house and you're ready, check out our mortgage calculator to help you run some numbers. I'm going to drop a link to all of that in the description below. As always, be sure to subscribe to this channel, hit the like button, and share this with everyone in your life who has arms, who's thinking about getting an arm, and who has the right

to bear arms. That should cover everyone. Oh, and Creed fans. Share it with all the Creed fans in your life, they would for sure love this. And special shout out to our amazing guitar player and senior producer of the Ramsey Show, my friend James Childs, for making a little cameo in today's video. I lifted.