Payment shock? Payment shock is the sudden and significant increase in your monthly mortgage payment when an ARM adjusts. Increases can be 30-50% or more. Always budget for the worst-case scenario when choosing an adjustable-rate mortgage.
What Is Payment Shock?
Payment shock occurs when your monthly payment jumps dramatically due to a rate adjustment or the end of an interest-only period. On a 5/1 ARM, the first adjustment after 5 years could increase your payment by hundreds of dollars per month depending on how much rates have moved and your loan's caps.
The worst-case scenario is when rates rise significantly AND your IO period ends simultaneously. A payment of $1,800 could become $2,700 or more. That is why lenders are required to disclose the maximum possible payment in your loan documents.
How to Prevent Payment Shock
Plan ahead by understanding your ARM's periodic and lifetime caps. Know the maximum rate your loan can reach and calculate what that payment would look like. If the maximum payment would stretch your budget, consider a longer fixed-period ARM or a fixed-rate mortgage instead.
Patrick Kevin Fagan recommends stress-testing your budget against the maximum possible payment. If you can comfortably afford the worst case, an ARM can be a smart financial move. If the worst case keeps you up at night, a fixed-rate loan may be a better fit.
