The Worst Case Scenario for U.S. Consumers

Thursday, May 11th, 2006
By Michael Lombardi, MBA for Profit Confidential

Let’s face it. For those of us who remember the early 1980s, and despite all the interest rate increases we’ve experienced in the past two years, rates are still low. A fixed 30-year mortgage in the U.S. is now only 6.18%. In the early 1980s, that same mortgage was over 12%.

But, here’s the problem:

Not so long ago, those smart fellows on Wall Street came out with a product called an adjustable rate mortgage, ARM for short. An ARM gave a borrower a choice each month to pay interest only, interest and principal, or a minimum payment that was less than interest owed that month with the remaining interest balance added back to the mortgage. Yes, your total mortgage could increase each month.

It was a novel idea. Consumers loved the concept and within five years U.S. homeownership hit 70%– a record high. About 10 million mortgages in the U.S. now carry adjustable interest rates. Many new homeowners were lured into ARMs that offered loss- leader pricing like interest rates of 2% for the first year or so.

Unfortunately, when so many Americans took out ARMs they didn’t consider that one day interest rates would rise. All ARMs reset to higher interest rates at some point, and that’s where consumers are facing difficulties. In some key U.S. states, 20% of ARMs that moved to higher rates are at least 30 days late.

So while today’s interest rates could still be viewed as historically low, to American consumers who went to variable rate mortgages or ARMs, their monthly mortgages payments have increased considerably. Yesterday’s 16th interest rate increase by the Fed was bad news for many financially overextended consumers.

Housing prices in the U.S., for the most part, have stopped rising. Image if you had a ARM where your principal increased each month but your house stayed at the same value. It’s a worst case scenario for U.S. consumers.

Hence, if you see the general stock market moving to new highs and are being convinced by your financial advisor or the popular media that rising interest rates have not yet taken a toll on the economy, think about the over five million Americans who took out ARMs over the past two years. For them, over-financing via ARMs has been a catastrophe. And anyone who tells you their pain won’t be felt in the general economy in time should take an introductory economic course.

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Tags: interest rates, stock market, U.S. home prices, U.S. mortgage rates

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Michael bought his first stock when he was 17 years old. He quickly saw $2,000 of savings from summer jobs turn into $1,000. Determined not to lose money again on a stock, Michael started researching the market intensely, reading every book he could find on the topic and taking every course he could afford. It didn’t take long for Michael to start making money with stocks, and that led Michael to launch a newsletter on the stock market. Today, Michael only employs the top market analysts and editors. Some of our recommendations have posted gains in excess of 500%! Michael has authored and published over one thousand articles on investment and money management. Along the way to building Lombardi Publishing Corporation, now with over one million customers in 141 countries, Michael became an active investor in real estate, art, precious metals and various businesses. Readers of the daily Profit Confidential e-letter are offered the benefit of the expertise Michael has gained in these sectors. Michael believes in successful stock picking as an important wealth accumulation tool. Married with two children, Michael received his Chartered Financial Planner designation from the Financial Planners Standards Council of Canada and his MBA from the Graduate Business School, Heriot-Watt University, Edinburgh, Scotland.Follow Michael and the latest from Profit Confidential on Twitter