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Bad Credit Home Loans: The ARM is Not For Everyone

By Gabriel Traverso
Mortgage Credit Problems Columnist


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Over the past few years home prices have risen such that many homeowners turned to alternative home loans like ARMs and interest-only mortgages. For those with bad credit this may not be the right move.

An Adjustable Rate Mortgage Means Rising Payments

An adjustable rate mortgage differs from a traditional fixed-rate loan in that you are often given a lower initial rate, maybe for a term of one month to several years, and then your mortgage rate moves with the financial index on which it is based. The problem is that a bad credit adjustable rate can carry a margin many points higher than the index to compensate the lender for the higher risk of a carrying a bad credit loan. Your payments could increase prohibitively when the ARM provision kicks in even if prevailing interest rates do not.

Bad Credit Mortgages Are a Short Term Solution

If you have bad credit, the sub prime rate you can get today is probably not the rate you're going to want tomorrow. What's so great about a thirty year fixed rate that is 5 points higher than the rate good credit borrowers pay? The idea behind taking a bad credit mortgage is that you make your payments, develop a better debt management track record, and put some distance between your deadbeat past and your good credit citizenship today. You want the lowest rate and payment available--for a couple of years.

ARMs: Betting On Your Future

Bad credit borrowers are different from other borrowers--your bad credit mortgage is a temporary solution, not a way of life. Find a hybrid ARM with a payment you can manage (if you can't then set your sights lower), get a rate that is fixed for 2 or 3 years, and make sure there isn't a prepayment penalty longer than your 2 or 3 year fixed rate period. Then use the next two or three years wisely.

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