ARM loans topped the charts in defaulted loans during the housing crisis. Why would anyone even consider this loan type today? Not only are people considering it – these loans are becoming more and more popular in 2017.
What’s the catch? There really isn’t a catch. It’s a matter of survival. Interest rates are rising. Fixed rate loans are seeing some of the highest interest rates of the last few years. Borrowers don’t want to lock in a rate that high, especially borrowers with a 30-year term. So what’s the answer? An adjustable rate loan. How do you know if it’s right for you? We discuss below.
Get Attractive Terms Right Away
New homebuyers want the lowest rate possible. Whether first-time homebuyers or not, it is just easier to have a lower payment right away. Paying closing costs, moving costs, and just getting into the swing of things is expensive. If you add a high mortgage payment on top of that, you have a recipe for a stressful 30 years ahead of you. Why not start it off on the right foot? That is why people choose ARM loans right away.
Today, the initial rate on an ARM loan is ¾% lower than a fixed rate. That might not sound like a lot, but it adds up. If you figure the savings over a period of 5-10 years, you can see the difference. Even though you only get that lower rate for the introductory period, which may range from 5-10 years, it is still a chance to save. If you have short-term plans to live in the home, it suits you even more. You never have to see the higher interest rate because you will sell the home before it gets to that point.
ARM Loans are Less Risky Today
If the housing crisis taught us anything, it was to be more cautious. This caution led the government to put regulations on ARM loans. You don’t have to worry about crazy high-interest rates or weird terms anymore. Today’s ARMS cannot:
- Have prepayment penalties
- Adjust more than one time per year
- Adjust beyond its caps
This makes it easier for homeowners to refinance out of the ARM before it adjusts if they desire. They also can predict the worst-case scenario based on the interest rate caps set before you close on the loan. Just how does the ARM work? We discuss the process below.
How the ARM Works
You will notice an ARM loan signified like one of the following:
The first number signifies the period the interest rate is fixed. You know the interest rate before you close on the loan. It is usually quite a bit lower than the fixed rate alternative. If you have a 10/1 loan, then you pay the initial interest rate for the first 10 years. The rate never adjusts during this time.
After the period expires, though, the rate changes. The second figure in the number is how often the rate will change. If it is a “1”, it means the rate will change annually. This is usually the case for all ARMs today. This generally means your interest rate will increase every year. The first change is usually the hardest to handle only because your initial interest rate is likely much lower than the adjusted rate. The good news is there are maximums that the rates can adjust. The bad news is, they adjust and you cannot ever predict how much.
The Downside to ARM Loans
The obvious downside to ARM loans is the unpredictability of the loan. You have no way to tell what interest rates will do between the time you take out the loan and its first adjustment. What happens if you cannot afford the new payment? You have to scramble to try to refinance quickly before you default on your loan. This is not an easy feat. This is why there are only certain borrowers who do well with these loans. Just who are they?
Borrowers who Benefit From ARM Loans
It could be argued that anyone could benefit from an ARM loan. Afterall, who wouldn’t like a lower rate for a few years? However, the adjustments the rate makes just makes it too hard for most people. The exception to the rule, however, is those who will only own the home temporarily. If you buy a home that you know is not your forever home, you benefit from the ARM. These borrowers are those who have a job that relocates them or the one who just knows they like to move every few years. Knowing you will not be in the home long-term enables you to take advantage of the lower rate because you don’t have to worry about it adjusting.
Borrowers who do end up staying in the home, do have the benefit of refinancing. Of course, this assumes they have good credit, low debts, and enough money to refinance. That is a lot to depend on, isn’t it? This is why borrowers who think they will spend less than 5 years in a home make the best candidates for the ARM loan.
No matter which way you look at it, ARM loans are making a comeback. They often give borrowers more buying power, which in a state of rising interest rates is important. They also help borrowers keep their costs down for a few years at least.
Only you know which type of ARM is right for you. Different lenders have different programs. Obviously, the longer fixed-rate period you take, the higher the interest rate, but they still beat fixed rate loans. If you are unsure about how long you will stay in the home, choose conservatively. The fixed rate option would probably be the best choice, but if you want an ARM, stick with the 10/1. This gives you 10 years to decide what to do next. If you decide to stay, you can always refinance into that fixed rate down the road.