Clean Up Your Bad Credit and Get a Better Rate with a 2/28 ARM

By Gina Pogol
Mortgage Credit Problems Columnist

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A recent article by the Washington Post indicated that federal regulators were concerned about 2/28 adjustable rate mortgages.

The loans feature a lower start rate, then after 2 years they convert to adjustable rate mortgages (ARMs) with rates that can go up significantly. The feds anticipate difficulties for borrowers when the initial lower start rate (which is good for 2 years) adjusts to a higher rate, causing some homeowners to experience problems making their payments.

Why a 2/28 Subprime Mortgage Loan?

The reason that a borrower with bad credit might take this kind of home loan is that subprime mortgages aren't meant to be held forever. Unless you are planning to have bad credit for the rest of your life it makes sense to take a loan that you don't need to keep too long. When your credit improves you're going to refinance to a better loan anyway. So why pay the higher rate for a 30 year fixed subprime mortgage?

You've got 2 Years to Get Out of a Bad Credit Mortgage--Use Them Wisely

Subprime loans will get you into a house or help you cash out some equity if you need it but they should be a short-term solution. That's why there is no need to take a 30 year fixed rate loan (with a higher rate) if you're a subprime borrower. You have two years before your rate adjusts--two years to get your bad credit turned around. The most critical thing you can do is pay your bills on time, especially your mortgage. Two years of perfect payment history can offset a lot of late payments from the past. When your mortgage is ready to adjust, you should be ready to refinance to a better loan.

Look out for Prepayment Penalties

Most if not all of these loans come with a prepayment penalty, which can range from one to five years. It's important that you shop around for 2/28 with a prepayment penalty of no more than two years--that way you can refinance out of the loan and won't be forced to make higher payments if the rate adjusts way up.

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