There are many reasons why the housing crisis occurred.  Banks, and other lenders, had taken up the trend of creating sub-prime loans. The housing “bubble” burst, which meant that homes that had a high amount of value suddenly were not worth the amount of money it originally cost to purchase them.  Another thing that contributed to the housing crisis were adjustable rate mortgages.

An adjustable rate mortgage, or ARM, is a home loan with an interest rate that does not stay the same.  It is the opposite of a fixed rate mortgage loan, where the interest rate is “fixed” in place and will not change.  Instead, an adjustable rate mortgage has an interest rate that may move up or down, depending on changes in an index, and a margin.  In short, these changes mean that the person who has an ARM mortgage could end up paying a different amount each month.  While it is potentially possible for the interest rate to go down, this is extremely unlikely.  In general, interest rate will continually increase.

The initial interest rate on an adjustable rate mortgage will be somewhat lower than the starting rate on a fixed rate mortgage.  This can make an ARM deceptively attractive, until the rate changes, and the monthly payment increases.  In some cases, lenders downplayed the effect the increased rate would have on a person’s monthly payment.  In other cases, people simply didn’t understand how much the rate could increase due to unforeseen changes in the market.  The result was that a lot of these ARM mortgages increased their interest rate at the same time, and it caused a massive amount of loans to go into default.

There is more than one kind of ARM.  An Interest Only Mortgage, or I-O, would allow a person to have a very low monthly mortgage payment.  This meant that for the first few years a borrower would only be paying off the interest generated on the mortgage loan for one particular month.  They would never pay off the initial amount they borrowed, or even reduce it.  Next, the monthly payment would be raised, in order for the person to start paying off some of that initial balance.  It was this increase that caused many mortgage holders to be unable to keep making payments, and these loans were defaulted as well.  Numerous loans defaulting at once made the housing crisis much worse.