Financial Literacy 2007 - Mortgages
Option ARM blues


Phil and Stacey Fleming of California are in a situation that many can identify with – raising a family in one of the most expensive housing markets in the country. Phil, 42, works in administration for a school district. Stacey, 35, works with special education students in a middle school. They have three children – two sons, ages 14 and 11, and a daughter age 8.

The Flemings purchased their home two years ago after relocating from Florida, and they intend to remain in the home for at least another 10 years. In addition to pursuing graduate studies at the University of Southern California, Phil has been spending his weekends renovating the home for the past two years.

The Flemings

The challenge: Used an option ARM to buy their home; mortgage now larger than when they bought house.

The plan: Get finances in shape to make refinancing to a fixed rate possible.

Follow-up: Able to increase savings while refinancing to a low-interest, fixed-rate mortgage.

The problem

The Flemings face a situation thousands of recent home buyers can relate to. Their option ARM started off great but is now zapping their bottom line.

Phil and Stacey bought their home with an option ARM and are finding it increasingly difficult each month to make a payment large enough to actually reduce their mortgage. The balance on the loan has increased by $30,000 since the loan originated two years ago. Further, they say they cannot make the higher interest-only payment, much less a payment that is going to chip away at the loan balance.

An option ARM permits borrowers to choose how they wish to make their payments each month: a traditional, fully amortizing payment; an interest-only payment; or a minimum monthly payment that is often not enough to cover the interest due. While Phil acknowledges the loan "was originally attractive for its low monthly payment," they've also learned over the last two years that rising interest rates mean higher monthly payments. They resort to the minimum payment each month, and watch as the interest-only payment continues to ratchet higher.

This may seem like a cut-and-dry issue, but for a more complete perspective, we reviewed Phil and Stacey's overall financial picture.

Over the past two years, Phil has spent weekends fixing up the home, doing the labor himself and sometimes with the help of their 14-year-old son. The costs for materials have been absorbed by a home equity line of credit. As the outstanding balance on that line of credit has grown, rising interest rates have helped push the interest-only payment steadily higher. The couple makes just the interest-only payment each month. Phil expects to incur another $8,000 to $10,000 in home improvement expenses over the next year to complete the job.

Between rising interest rates, the increasing home debt and a schedule that constantly has them on the go, Phil and Stacey are starting to feel the strain.

Flemings' financial picture

They have two car loans, $5,600 in credit card debt, student loan debt from Phil's undergraduate days, and expect another $1,500 in costs for the graduate program in which Phil is currently enrolled.

While Phil works year-round, Stacey is off during the summer. With Stacey home during the summer, and the close proximity of their home to the school where she works, they are able to avoid burdensome child care expenses.

While they don't adhere to a budget, Stacey keeps detailed records and uses Quicken to help manage their finances. By "paying things as they come in," Phil and Stacey have good credit that has afforded them attractive interest rates on all of their borrowings.


Their property taxes are not escrowed, but they are disciplined about setting money aside into a dedicated account monthly and pay in two installments each year. This system has worked well, although they admit that they must occasionally tap that account when income is lean, particularly in the summer months when Stacey is home.

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Claes Bell

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