Personal Finance 

Return of the Adjustable Rate Mortgage

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MortgageRight after the mortgage meltdown and the financial crisis, many people began shunning adjustable rate mortgages. Many of these mortgage products featured “teaser rates” that re-set after a few months, or that had other characteristics of subprime loans. However, as the economy recovers somewhat, and as borrowers look for good deals, ARMs are making something of a comeback.

The New York Times reports that ARMs that re-set five to seven years down the road, with a cap after the fixed rate period, are on the rise. One of the reasons that borrowers are looking into ARMs is due to their usually lower interest rates. The initial rate on an ARM is often lower than what can be had on a fixed rate mortgage, and it can mean some savings on interest. However, it is important to make sure that you can truly afford your mortgage — no matter what type you get.

Can You Afford the New, Higher Mortgage Rate?

One of the ways that mortgage lenders convinced borrowers to get ARMs in the past was by insisting that they would probably make more money later, and be able to afford the higher mortgage rate. Another ploy was to tell borrowers that they could just refinance down the road. Of course, with the housing market crash and financial crisis, home values plummeted so that refinance was impossible for many with re-setting mortgage rates — and wages haven’t kept pace with other costs so many were unable to cope with the higher payments.

Before you agree to an ARM, you should consider whether or not you could afford it with the higher payment. Find out what the new payment would likely be, along with how much you would pay if the maximum interest rate on your loan were reached. Base whether or not you can afford the mortgage payment on that rate, instead of what you are paying at first.

Looking for the Right ARM

An ARM can be a great decision for some. However, it is important that you shop around for the right ARM, rather than just taking what any mortgage lender is handing out. Not only should you consider the ultimate affordability of the ARM, but you should also consider the following:

  • Avoid an ARM with prepayment penalty. If you refinance, you could pay a big cost.
  • Look for a more standard 5/1 or 7/1 ARM.
  • Make sure there is a cap on the maximum rate charged on the loan.
  • Clarify that you are not dealing with a teaser rate.

An ARM can work out for a number of people. If you are looking for a way to save on interest, you can take advantage of low rates. Those looking for jumbo mortgages can als0 benefit. Because a huge loan has a higher principal, it is clear that a smaller interest rate, even if it only for five years, can save you a great deal of money. And, with interest rates on fixed rate mortgages creeping up, an ARM appears much more attractive — especially if you consider that some ARMs are hovering at around 4% right now.

(photo: revdancatt)

{ 13 comments, please add your thoughts now! }

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13 Responses to “Return of the Adjustable Rate Mortgage”

  1. Matt K says:

    what’s the advantage of a 5/1 arm over a 5/5 arm? My credit union is pushing their 5/5 arm, and it looks like it could be better than a 5/1….

  2. Vic says:

    Rates can only go up. You’d be a fool not to lock in at 5% for 30 years. I wouldn’t trade the less than 1% spread for uncertainty of my mortgage payment down the road

    • mannymacho says:

      Yeah, but that’s assuming you have a good chance of being in the house for more than 5 to 7 years. If you know with a certainty that you will move or have it paid off, the lower rate would be better. (but I guess you could also make the case that if you are paying off your house in five years, who really cares what the rate is?)

  3. I’ve never seen the benefit of an ARM. Too much is unknown about what things will be when it comes time to adjust. Fixed rate is the only way to go in my opinion. 15 yr fixed is preferred, do a 30 yr fixed if you have to.

  4. billsnider says:

    I rememeber in the 70’s when interest rates went to 18%. If I am looking at 30 years, I would opt for the fixed rate.

    Bill Snider

  5. After a 30 years of higher bonds prices and falling rates the risk/reward ratio of borrowing at an adjustable rate is unacceptable. Unless you KNOW you will only need the loan for a short period of time everyone should opt for a fixed rate mortgage. The risk of high interest rates over the coming years is very high.
    Ken Faulkenberry

  6. Erik says:

    Why would you trade a sure thing for a small possibility of gain with a large possibility of getting owned?

    Having the amount of your mortgage payment be a moving target depending on your lenders whims seems like a bad idea.

  7. Don C says:

    The average stay in a home is only 7 to 10 years. If you know (for sure) you will be moving in the next 5-7 years, why not take advantage of the lower rate? ARMs are not for everyone. Those who got into them without understanding the risk are helped contribute to the housing mess.

    • skylog says:

      i see the opportunity you are suggesting, but it is the whole (for sure) part that bothers me. there are just too many variables that can change that for sure status. that is what would keep me away.

  8. elloo says:

    I had a 30/1 ARM years ago (a dumb move). Every year for 7 years, I lost sleep in the weeks before the new rate was posted worrying if I was going to get a bad surprise. (I never did, thankfully.) Now, I only do fixed rates so I can sleep better.

  9. Jane says:

    I currently have an ARM on one of my properties, it was my home but now it’s a rental. Long story and not relevant to this comment. It was a 7/1 and adjusted for the first time last year, down to 3% which resulted in a payment that was close to 1/2 of what I was paying. I feel comfortable with the Loan because at the most it can go up to 10.7% per the contract and I’ve continued to pay the same this year as before. That means when my rates go up, they have to at some point, I may still end up with a lower payment than I have now based on the fact I’ve paid down principle.

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