Most people sleep better at night knowing they have the security of a fixed rate mortgage, they come in terms ranging from 8 years to 30 and the interest rate will never change. When it comes to your home you likely want the least amount of surprises as possible. I myself have a fixed rate mortgage because I anticipated being in my home for an extended period of time. There are other options that can save you money if used properly.
What is an ARM (Adjustable Rate Mortgage)
An ARM is a mortgage amortized over a set period of time (meaning it is scheduled to be paid in a certain amount of payments over a certain amount of years) But the payment is fixed for a shorter period of time. So you can have a mortgage that extends 30 years and the rate is 4%, but that 4% is only fixed for 5 of those 30 years. The remaining 25 years the mortgage rate will adjust to current market conditions. So you will see your payment change every so often as it adjusts to where the market is.
Adjustable Rate Mortages in the past
Over a decade ago while we experienced the housing bubble, adjustable rate mortgages accounted for a large percentage of the housing market because they had attractive interest rates. People were not aware of the potential adjustments these loans could have; sometimes as much as 3 or 4 points in a single adjustment. These were sub-prime predatory loans given out by defunct mortgage companies that capitalized on an inflated market. Currently as ARM’s make a comeback, we see new checks and balances put in place to prevent a re occurrence of these events.
Safeguards in the mortgage
Preceding Today’s adjustable rate mortgage standards we would have predatory mortgages that would be fixed at a “teaser rate” much lower than the current market. This would be fixed (meaning it would not change) for anywhere between 1-3 years, then it would reset to current market price. Lenders would what’s called a “margin” in the loan, this was a price on top of the rate paid to the lender. So even if the rates stayed the same buyers would often see their payment rise.
The difference in Today’s adjustable rate mortgages are very distinct. An example of a current ARM is the 5/1/5. The numbers represent the following:
1) 5 = the number of years the fixed or “teaser rate” is locked
2) 1 = it can adjust 1 time per year. Then it is fixed for that year at this rate
3) 5 = the maximum it can adjust above the initial locked in “teaser rate”.
So a 5/1/5 arm that was locked in at 3.5% would be fixed at 3.5% for 5 years, on the 6th year it would adjust a maximum of 2% per year. The maximum it can adjust upwards to is 8.5% and the soonest would be 2.5 years.
It’s important to know that it can adjust a maximum of 2% when it does adjust, but it doesn’t necessarily mean it will adjust that much.
Why buyers are attracted to these loans
There are a few good reasons these loans are gaining popularity, mostly because of the low introductory rate and the safeguards in place to prevent payment shock. But these loans also have the ability to adjust downwards, so a decrease in the market can actually save you money as your rate declines. Some buyers experience monthly savings without having to refinance.
The Take Away
The bottom line is an adjustable rate mortgage is a tool, and like any tool you use it for the job needed. If your anticipating you won’t be in your home for an extended period of time, or that the market is on a down swing and you feel it will continue, an ARM might be a viable choice. If you intend to sell your home in the first 3-7 years and move onto something bigger, they might be a good choice. My personal preference is the fixed rate mortgage because my goal is to stay in my home for a good number of years, and with rates so low it didn’t pay for me to risk it adjusting upwards.
I hope this has been helpful, please contact me with any questions regarding real estate or lending.
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