ARMed and dangerous?

The nagging feeling in the Jimenez household started shortly after the sale closed back in early 2005.

When Amy and Kevin Jimenez bought their house on Daniel Island, they opted for an adjustable-rate mortgage instead of the traditional 30-year fixed-rate loan that had financed the homeownership dreams of previous generations.

The appeal: reduced interest payments for the initial five-year term. The risk: payments would automatically adjust up or down after that period based on factors beyond the couple's control.

That uncertainty began to gnaw at them almost immediately, but it took on a heightened sense of urgency as the global banking crisis began to spread last year.

'At that point, the market crashed and it made us really aware that we weren't comfortable sticking with an ARM,' she said.

The Jimenezes were lucky — they planned carefully and gave themselves some options. But other on-edge holders of adjustable rate mortgages may not be so fortunate.

Thousands of homeowners in the Charleston area have taken out ARMs that are scheduled to reset for the first time over the next few years, according to one estimate. When that happens, their payments will start floating up or down, adjusting and readjusting periodically based on various economic indices at that particular time.

Rate case

While they are at historic lows now, home-loan rates are expected to rise again. Also, property value are in decline and banks are pickier about the loans they make. Because of those factors, borrowers who either cannot refinance or sell could find themselves ensnared in the ARM trap.

Financial experts say the approaching wave of ARM resets represent a ticking time bomb that could trigger a new round of foreclosures and deliver yet another blow to the already-hurting residential real estate market.

'Reality has set in and looking down the road, it's easy to see that some of these borrowers are never going to make it,' said mortgage analyst Peter Gumbinger of New Jersey-based HSH Associates, a consumer loan data provider.

First American CoreLogic, which tracks more than 111,000 Charleston-area mortgages, estimates that 11,250 of those will be up for their first readjustment over the next few years. And that's likely on the low side because the firm's sample is limited.

Nationally, about 10 percent of all mortgages valued at $1 trillion have adjustable interest rates.

Gumbinger said it's impossible to predict the exact magnitude of the ARM problem because some borrowers, socked perhaps with an unexpected job loss or divorce, will default on their loans before they reach their readjustment periods. Also, it remains to be seen how lenders will respond. Some may approve lower payments for financially strapped borrowers on a temporary basis through loan modifications.

At the moment, homeowners whose ARMs are resetting now are benefiting from some of the lowest rates in history. That means their monthly payments could decline after readjusting, Gumbinger said.

'Frankly, most are going to be pleasantly surprised because ... interest rates, on the whole, are going to go down,' he said.

And ARMs aren't necessarily financial dynamite. Kimberly Jackson-Colvin recently refinanced into one for her home off College Park Road. Because it was part of a government-sponsored program for veterans, the mortgage has strict caps and is helping her pay down her principal faster, she said.

'I need to get this mortgage paid down,' she said.

But the cheap money isn't expected to last, said Guy Cecala, publisher of Inside Mortgage Finance. He said monetary policy regulators have kept key rate indexes artificially low during the global credit crisis.

'It's not a normal market by any stretch, and realistically, we'd expect the (rates) to drift upwards in the next year or more,' Cecala said.

The uptick in borrowing costs, combined with other unforeseen financial challenges that individual ARM borrowers will face, could stand in the way of what was considered a few years ago a routine refinancing.

'Three or four years ago, people did take the (ARM) gamble because they thought there was going to be that silver lining in the economy and interest rates wouldn't be going up. If you have an adjustable rate, you could either sell or refinance,' said Kevin Brookes of Southern Trust Mortgage's Daniel Island branch.

Clamping down

More recently, though, credit standards have been tightened dramatically. And Brookes noted that many homeowners borrowed money against their residences, draining the amount of equity they built up during the boom years.

Also, property values have since fallen, putting appraised values in question and creating another layer of refinancing challenges.

'A majority of the roadblocks are with equity,' Brookes said. 'People just don't have the equity to refinance.'

The option of last resort for these borrowers — an outright sale — is not as simple as it once was either. Sellers are having to cut prices to attract attention in a market with roughly 10,950 other homes for sale.

Mortgage analysts say they're especially worried about a class of floating-rate loans called option ARMs, which were especially attractive to real estate investors. The payments on those notes barely pay down the principal, so borrowers might have little or no equity to show when seeking to refinance.

'The kinds of people that took out option ARMs tended to be people who could not prove their income or speculators who didn't want to prove their income,' said William Harrison, a local developer who teaches real estate at the University of South Carolina's Moore School of Business. 'Some of it is people who shouldn't have been in real estate to begin with. The instrument was ripe for abuse.'

Harrison pointed out that Charleston, compared to other cities in the state, could be affected disproportionately by these loans because the area attracted more speculators during the good times.

But as homeowners like the Jimenez family show, peace of mind for ARM borrowers is not out of reach.

Two years before their first rate adjustment was to kick in, they began the refinancing process before the home values in their neighborhood fell further. The appraisal went through, and their income had increased to a level that allowed them to take out a costlier — but predictable — fixed-rate loan.

'It's a good feeling,' Amy Jimenez said.

Reach Katy Stech at 937-5549 or kstech@postandcourier.com.