United States Prime Rate: Interest Rates Are Rising, Which May Translate to Financial Dire Straits for Those with Adjustable-Rate Mortgages (ARM's)

The Prime Rate has been on the rise since the summer of 2004, and with rising interest rates comes higher minimum payments on revolving credit card balances, higher payments on Home Equity Lines of Credit (HELOC), and, for those who opted for an Adjustable-Rate Mortgage (ARM) that's tied to the Prime Rate, it means that the mortgage bill has been eating up more and more of the household budget (depending on when the low interest "teaser" period ended.)

Quick Tip: A Home Equity Loan (HEL) is typically more
consumer-friendly than a Home Equity Line of Credit (HELOC).

When compared to other mortgage products, ARM's are often easier to get, and sometimes borrowers signup for ARM's that they can't afford: when the low interest period on the ARM ends, the monthly payment then rises to a level that the borrower didn't anticipate, and can't manage. This can mean serious financial trouble for the borrower, even foreclosure in the worst cases.

The folks at Bills.com recently issued a press release with some great tips on how to avoid the financial headaches that often accompany rising interest rates. Here's a clip:

"As any real estate agent knows, home sales heat up with rising temperatures every summer. Now, with mortgage interest rates more than a full point higher than at this time last year, fuel costs riding high, higher minimum credit card payments and consumer debt still raging, many U.S. homeowners risk foreclosure on their homes -– but they don’t have to lose their slice of the American dream.

'Last year, 31 percent of home loans issued were adjustable-rate mortgages (ARM's), which could spell big trouble as fixed mortgage rates hover around 6.83 percent and ARM's are poised to go much higher,' said Brad Stroh, chairman of Bills.com. 'Holders of ARM's will be paying an additional $14 billion annually for every 1 percent increase in mortgage rates. People who bought homes at the edge of their spending ability with an ARM could face dire consequences as their mortgage payments increase -- but they can take steps to keep their financial situations in check.'

According to the Mortgage Bankers Association of America, 4.7 percent of U.S. mortgages were delinquent at the end of 2005. With $9 trillion in outstanding U.S. mortgage debt, that places $423 billion at risk of foreclosure. Homeowners who are at risk (as well as prospective homeowners) can use the tips below to avoid mortgage trouble.

How to prevent problems:

Create a budget and don’t stretch yourself too far. The unexpected can and does happen to millions of Americans each year. For people who live at the far edge of their means, one life event can hijack their lives and lead to defaults on bills and/or mortgage payments. The key is to build a detailed budget of income and expenses, making sure to allow some breathing room to weather an unexpected downturn.

Be very careful with ARM's or interest-only loans. These types of loans let borrowers qualify for more expensive homes -– but beware as rates (and payments) climb. If you can barely afford the payment on your ARM or interest-only mortgage, you are asking for trouble in a few years when the 'teaser period' expires and your loan re-sets to a fixed rate. Be sure you have extra cushion in your budget with these loans.

Don’t jump to refinance your home to pay off credit card debt. Many people faced with large credit card debt or other unsecured debts consider refinancing their homes. But this strategy only moves the debt, securing it with your home. That puts your home is at risk of foreclosure if you are unable to pay. If you are not confident that you can keep up with your home loan payments, consider debt resolution or another debt relief option.

'We can’t emphasize enough that people must educate themselves about what they're getting into with a mortgage,' Stroh added. 'Overall debt problems will continue to escalate unless people rein in their spending to live within their means. Unfortunately, for some people, that may mean losing their home to resolve their financial situation.'

How to avoid foreclosure -- if it’s already on its way:

Enter into a forbearance agreement. For a temporary hardship, lenders might grant a forbearance agreement to lower –- or eliminate –- payments for a limited time.

Consider loan modification. A loan modification seeks a permanent change to the loan, such as lowering the payment and extending the loan’s term, or incorporating any delinquencies into future payments.

Obtain a 'deed in lieu' of foreclosure. A 'deed in lieu' essentially allows the borrower to return the title or deed of the property -– giving the home back -– to the mortgage holder to avoid foreclosure.

Sell the home. Selling your home may not be ideal, but it is a way to avoid foreclosure proceedings on your house and pay back your lender.

Refinance the loan. It may be possible to refinance your mortgage for a lower interest rate and/or lower monthly payment (this is much different than refinancing to take cash out to pay off credit cards). However, if you already have had late payments on your mortgage, the interest rate offered to you may be too high to lower your monthly payment. Educate yourself on current rates by checking online rate comparison sites and using online calculators to determine the real costs of refinancing. These tools are available on a number of Web sites, including http://www.bills.com/calculators/.

Be cautious. Be wary of so-called equity skimmers. If your house is facing foreclosure, you will probably receive numerous solicitations from companies looking to 'help' you prevent foreclosure by offering to sell your home for you or by taking ownership of your home. In most cases, these solicitations are scams trying to take advantage of people in difficult situations. The perpetrators aim to snatch the equity you have built up in your home.

In many states, foreclosure rates have already started to increase, especially impacting the segment of the population that carries adjustable-rate mortgage loans, whose payments climb upward with every interest-rate increase. However, homeowners can make choices -– ideally, before they purchase a home, but even after problems arise -– that will help them keep a home, or at least minimize the damage a foreclosure could have on their futures."