Final answer:
The loan amount for a historical and a worse-case adjustable-rate mortgage (ARM) example is typically based on a home purchase scenario of $250,000. This figure demonstrates the dramatic increases in mortgage payments that can occur when introductory rates expire and the interest rates adjust upwards, highlighting the risks of ARMs, especially if rates are tied to inflation.
Step-by-step explanation:
Understanding Adjustable-Rate Mortgages (ARMs)
When considering the historical and worse-case examples for an adjustable-rate mortgage (ARM), the loan amount is typically based on a scenario where the borrower has taken a loan to purchase a home. In these examples, we can refer to a loan amount of $250,000, which was common during the pre-recession period. This loan amount, combined with the low introductory interest rates offered by ARMs, illustrates how monthly mortgage payments can increase significantly if the interest rate jumps as the initial period expires.
For instance, the monthly interest payments on a $250,000 mortgage would increase from $833 at a 4 percent introductory rate, to $1,250 at 6 percent, and potentially to $1,750 or more as rates rise further. This illustrates the financial difficulties faced by borrowers when the low introductory rates adjusted to much higher rates, especially for those who had opted for zero-down ARMs, without thorough consideration of future rate increases and their own ability to pay once the rates adjusted.
The ARM is described as a loan that varies with inflation. If inflation were to rise by two percentage points, the interest rate on an ARM would rise correspondingly. This has the potential to make the interest payment grow, depending on the terms set at the beginning of the mortgage agreement. ARMs can indeed have lower initial interest rates compared to fixed-rate loans, but the lender is protected from higher inflation which may decrease the real value of loan payments over time.