Question: After my husband and I lost a large part of our investment portfolio over the past four years, he tried to play “catch up”, took too much risk, and lost even more. We were forced to cut back on everything and even terminated his life insurance. At one point we were going from month-to-month on our Social Security and running up debts on our credit cards. Then my husband hit on the idea of tapping into the equity on our home because interest rates were so low.

We took out a 10-year, interest-only, adjustable-rate mortgage and borrowed 85 percent of our home equity. We made minimal payments each month, but immediately used more than $120,000 to pay our debts, and used much of the rest just to live on. My husband died of a heart attack last year, and the monthly payments have begun to increase. At 67, I‘m getting his Social Security ($1,400 monthly) and have only $40,000 of borrowed money in the bank. It’s taking a long time to sell our house, and it’s unlikely that I will get enough to pay off the mortgage. While I share in the blame with my husband, I hope you will warn others our age about taking risk and taking out quick-fix mortgages.

Answer: We believe these types of mortgages are tragically bad choices for seniors like yourselves, not to mention others who may find themselves with unmanageable payments down the road, homes they cannot sell, or homes that have decreased in value to less than their mortgage balances.

In contrast to a fixed-rate loan that locks in your rate, the Adjustable-Rate Mortgage (commonly known as “ARM”) gives borrowers an initial sense of security when they see that lower interest rate and lower monthly payments – for a while. But these loans offer little protection against higher interest rates and devastating results in the future.

As interest rates begin to increase from their record lows, borrowers can expect upward adjustments each year, generally with a cap over the life of the loan that is written into the contract. Oftentimes, “teaser rates” during the first year are followed by rates that are tied to such indexes as Treasury bills plus an added “margin”. An ARM, for example, that increases 2 percent per year over four years will play havoc with folks on fixed incomes.
Experts say that the factors you should consider before taking an ARM include 1) your best “guesstimate” of the unpredictable direction of interest rates in the future, and 2) the length of time you plan to stay in your home. Generally, if you are not planning to move within the next five years, you should lock in a fixed-rate loan.

While interest-only payments allow folks to buy more expensive homes and defer principal for up to 10 years, the unpaid principal balance will be fully amortized over the remaining 20 years of the loan at unpredictable rates.

Retired seniors who are financially squeezed and Baby Boomers who are caught between helping parents, educating children, and planning for their own retirements should be realistic about their futures and not try “quick fixes” that will cause greater financial problems down the road.

Taking the NextStep: Borrowing, like investing, should be part of a coordinated plan, not a knee-jerk reaction to a situation. We believe that If you are going to leverage your home equity, you should have sufficient life insurance and long-term care insurance in place, in case what “just can’t happen” -- does.