Is an ARM Right for You?
Adjustable-Rate Mortgages (ARMs) have been making a comeback. Last year, the adjustable-rate mortgages were higher than the 30-year fixed. But lately that’s been changing, and ARMs have been considerably lower than their 30-year fixed counterparts.
Adjustable-rate mortgages come in an initial period fixed rate of five years, seven years, and 10 years. We have really been liking the 7-year adjustable-rate mortgages. It gives you a fixed rate period for the first seven years, and after seven years, it will begin to adjust once every six months. The 7-year ARM interest rates have been coming in around 2.306% (APR 4.732%), compared to a 30-year fixed today at 2.875% (APR 2.933%).
One example that we looked at recently was a client of ours who was in a really good rate of 3.5% but wanted to save a bit more monthly. He was thinking about refinancing into a 30-year fixed at 2.99%, but the savings just were not enticing to him. He wanted to save a little bit more than what the 2.99% fixed rate would allow, since he was already at 3.5%.
On his $500,000 loan amount, the amount of interest paid over seven years at 2.25% is $72,000, compared to a 30-year fixed at 3.5%, which is $114,000.
Over the seven years, he is going to pay $42,000 less in interest by refinancing into a 7-year ARM. This client is thinking of having their house for about 5 to 7 years, and then he would like to upgrade into something bigger. This makes the 7-year ARM a great fit for him, because he is not planning on having the house longer than seven years.
Sometimes I have clients say, “Well, what if I end up wanting to stay in my house longer?” My answer is you are okay if you stay in an ARM longer than the initial period. The reason why, is you will have paid down the principal amount considerably in the first seven years. Even if the rate goes up for years eight, nine, and 10, you have already paid down the loan quite a bit, so you would be paying a higher interest rate on a smaller loan amount.
Furthermore, you just saved $42,000 in interest so even if you start paying more in years eight, nine, and 10, it’s going to take a while before you breakeven on that $42,000 savings.
If you are nervous, a 10-year ARM is also a great option.
If you are not planning on being in your house for very long, maybe you’re buying a condo or a townhome, or you’re planning on expanding your family, a 5-year ARM has even lower interest rates that is fixed for 5 years.
Depending on your situation homeownership duration varies. The average loan in America only lasts 3 to 5 years before homeowners decide to either trade up to a bigger or better home or maybe decide to downsize. In fact, only 10% of loans in America actually make it to year seven. This is another reason why I really like the seven-year ARMs.
A lot of the time adjustable-rate mortgages receive a bad rap. It’s true that in the 2008 financial crisis there were a lot of bad ARMs out there. They adjusted after just two years and they adjusted quite significantly, which caused many people to lose their homes.
Today’s ARMs are different, since they are fixed for a five, seven or 10-year period, and the interest rates are considerably low.
ARMs are definitely not for everybody, but if you are not planning on keeping your house, or the loan for that matter, for 30 years, if used properly, ARMs are not bad products. The important thing is to understand them.
