Adjustable Rates Haunt Homeowners : Many Are Feeling the Pinch as Monthly Payments Soar by Hundreds of Dollars

Steven Doi’s American dream is giving him headaches.

Thanks in part to a 15% increase in monthly payments on his adjustable rate mortgage in the past 18 months, the San Jose telecommunications equipment salesman and his wife postponed buying a new car. They also don’t eat out as much and are scaling back vacations.

“We’ve made a number of sacrifices,” he says.

Vacation Postponed

So have Bill and Floy Hotarek of Laguna Niguel. The Hotareks, who work in the aerospace industry, have seen the payments on their $120,000 condominium jump nearly 18%, or more than $150 a month, in one year. They haven’t gone out to dinner or to a movie in six months, and like Doi, they have put off vacation plans so they can conserve their savings.

If rates keep rising, “this coming Christmas could be a very lean one,” says Bill Hotarek.

Doi and the Hotareks are among millions of Americans feeling the pinch of higher payments on ARMs and home equity loans, thanks to recent sharp rises in interest rates that have pushed up monthly bills hundreds of dollars per household. Mortgage payments have become the No.1 household financial concern in America today, overriding fears of inflation, medical bills or taxes, according to a national consumer survey to be released today by the International Assn. for Financial Planning and conducted by the Gallup Organization.

One in five consumers rank mortgages as their top money concern, nearly double any other worry.

The pinch may become worse in the next two or three months as many homeowners who bought homes in the traditional spring and summer peak buying periods are likely to see another annual adjustment in their monthly payments. Some homeowners who bought homes two years ago with ARMs may be seeing their monthly mortgage bills rise to as much as 40% over the levels they started with.

As a result, some homeowners--particularly those who bought in 1987 or 1988 and who are seeing their rates rise the most--are responding by reducing purchases of consumer goods or cutting savings. Part of recent declines in the growth of consumer spending is undoubtedly due to rising mortgage payments, although how much no one knows for sure, said John A. Tuccillo, chief economist for the National Assn. of Realtors.

Fortunately, the impact has been mitigated by a recent slowing in the trend to higher rates. Another moderating factor has been “caps” on ARMs that limit rises in interest rates or monthly payments.

But if rate rises resume dramatically--and some economists are not dismissing that possibility--it could increase the chances of an economic recession, possibly the first triggered in part by rising mortgage payments.

In the past, rising interest rates have helped trigger recessions by killing off demand for home purchases and shutting down new housing construction. The slowdown in housing demand has secondary effects that ripple through the economy.

Already there is evidence of a slowdown in new home construction, and higher rates and home prices have sparked a drop in sales of new and existing homes.

If rising ARM rates were to help trigger a recession, it would be a testament to how fast those adjustable loans have grown in recent years. It also shows the potential risks of the widespread practice of granting borrowers artificially low introductory “teaser” rates on the loans.

Buyers--particularly in last year’s frenzied housing market--turned in increasing numbers to ARMs as the only way to avoid being priced out of the market. Adjustable rate mortgages now account for just over half of all new first-mortgage loans nationwide, up from virtually nothing a decade ago. With teaser rates of 7% or so early last year, ARMs allowed buyers to qualify for much bigger loans than they could receive through traditional fixed-rate financing.

But today, most of the six-month teaser periods on those 1988 loans have ended. Many of those loans have already risen by 2 percentage points, the maximum allowed under “caps” that limit how much rates can rise in a given year and over the life of the loan.

For example, a homeowner who took out a $150,000 30-year ARM starting at 7% two years ago may have seen his rate rise to 9% last year and 11% this year. That would raise his monthly payment from $998 to $1,417--a 42% increase, said Pete Mills, senior research analyst at the California Assn. of Realtors.

Those low teaser rates are being recognized by many lenders as increasing their risks. Profits can be squeezed should rates that lenders pay for money to lend rise faster than rates they receive on loans. And some homeowners, labeled “teaser junkies,” have been refinancing old ARMs into new ones with lower teaser rates, perpetuating the risk.

Fortunately for California homeowners, the impact of rising ARM rates has not been as severe as in the rest of the nation. That is because a higher proportion of ARMs here are tied to the so-called 11th District cost of funds index, a measure that moves up much slower than the index tied to one-year Treasury bill rates that is used more frequently nationwide.

Many ARMs in California also have caps that, instead of limiting the annual rise in rates, instead limit the rise in monthly payments, usually to 7.5% per year. That is far less than the 20% annual rise in payments that can result if a loan rate rises by the 2 percentage points allowed under a rate cap.

Also benefiting California homeowners is the sharp rise in home prices. The median price of a home here has risen about 45% in the past two years, far higher than the 9% jump nationwide. That has made consumers more determined to keep up house payments, rather than lose their homes through foreclosure. Foreclosure rates have remained flat in California and nationwide in recent months, analyst Mills said.

Rising incomes can also offset some of the impact. Greg Carron, vice president of a vending-machine and distributing company in San Diego, says his income has risen more than enough to offset a rise in his monthly mortgage payment from about $1,100 to $1,300 in the past 18 months. Also helping him is a near doubling in the value of his La Mesa home in five years.

“I haven’t had to cut back on spending,” Carron says. “My income’s gone up more than the increase in my payment.”

Nonetheless, millions of other homeowners are worried, according to the survey by the International Assn. of Financial Planning, an Atlanta-based trade group representing financial planners.

The survey of 1,000 households nationwide, conducted last month, showed 19% listing mortgage payments as their top financial worry, up from 9% in the year-ago survey. Paying monthly bills, paying taxes and paying for childrens’ education tied for second, each with 11% of respondents listing that as their top concern. That was followed by paying for a car (10%), paying medical bills (9%), renovating a home (7%) and paying for food (5%).

Staff writer James S. Granelli in Orange County contributed to this story.