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Interest-only ARMs--one family's story

I spoke today with Sierra Stewart to find out how she and her family have made out since I featured them in a 2004 story about whether there was a bubble in the housing market. Here’s the beginning of that story:

How crazy is real estate getting in parts of the country? Ask Sierra and Corbin Stewart, who just bought a modest, 2,000-square-foot house in Pleasanton, Calif., for $730,000. Mortgage and tax payments will consume 55% of their income, forcing them to do without extras such as cable TV. Says Sierra, a 29-year-old marketer: “The other night we were doing our budget, and we almost called the real estate agent and said we want to get out.”

And here’s the conclusion:

Today’s housing prices are predicated on an impossible combination: the strong growth in income and asset values of a strong economy, plus the ultra-low rates of a weak economy. Either the economy’s long-term prospects will get worse or rates will rise. In either scenario, housing will weaken. Caveat emptor.

That story looks pretty accurate in retrospect, even though the prices kept rising for a couple of years after we wrote it. Anyway, I wanted to know if the Corbins had made out OK.

Sierra said that they put down about $150,000 on the house. A few months after they bought it, in September ‘04, they refinanced into an interest-only mortgage with a rate that was fixed at 5.25% for the first five years and then adjusted annually. By not making any payments against principal, they lowered their monthly payments to $2,500 from, as she recalls, around $3,300.

The Stewarts have about a year and a half to go on their ARM before it resets and they’ve been in touch with their mortgage broker about what to do. But since the current rate is so good, they haven’t been rushing to refinance.

I’m no expert with mortgage calculators, but it looks to me like refinancing into a conventional 30-year, fully amortizing fixed-rate loan would raise their monthly payment to about $3,500 a month. That’s painful, but not as bad as sticking with the ARM loan, which would apparently cost over $4,000 after resetting.

Says Sierra: “We’ve got some decisions to make.”

Unfortunately, she says she and her husband haven’t been able to salt much money away during the years of zero principal payments. The money has been eaten up by ordinary expenses, including gasoline and child care for their two young daughters.

Corbin works for the federal government and Sierra is in marketing. She’s an Amway distributor on the side. “Initially my goal for that (Amway) was to replace my job income so I could be home full-time. We were hoping to put money to the girls’ college funds. Now that may be our mortgage.”

Sierra isn’t complaining that they were treated unfairly. She’s not even super-worried because, she says, prices in Pleasanton are still higher than when they bought in 2004, so they could sell and move if they had to. “You can get wrapped up in the worrying and let it overtake you,” she said.

There are lots of families who are facing resets on interest-only ARMs, and their emotions range from complete confidence to abject terror. The Stewarts are in between.

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