Working as a mortgage broker I am constantly asked from potential clients what the benefit of an adjustable rate mortgage is, and why they should opt for that mortgage product over the 30 year fixed. This can be a difficult question to answer because adjustable rate mortgages have been misunderstood. You might be surprised to know many people are still choosing adjustable rate mortgages especially as we are seeing interest rates rise. The fact is, adjustable rate mortgages can be a great financial opportunity. I am going to outline some reasons why.
1. Lowest Possible Mortgage Rates. Interest rates are currently among the lowest in history and adjustable rate mortgage loans are one way to bring them even lower. An ARM has a fixed period where the rate won’t change, usually is 3, 5 or 7 years. The rate is lower, often a lot lower, than the more popular 30 year fixed rate mortgage. The market rate for an ARM today is lower than the current 30 year VA mortgage.
2. You Don’t Plan On Staying In A Mortgage Very Long. Because homeowners know they are only in a fixed-rate period for a short amount of time, an Adjustable Rate Mortgage is best used if you know you are moving before the fixed-rate period is over, if you plan on using the money saved by the lower interest rate to pay more towards your principal or if you’re planning on refinancing before the ARM begins to adjust. The current trend among VA loans is to refinance every 5 to 7 years. So this make the adjustable rate mortgage very enticing.
3. You Can Pay Less. Even including closing costs on a refinance, you are paying less money during the fixed-rate period over a traditional mortgage. For example on a $200,000 home loan, if you were to get a 30-year fixed-rate mortgage at 5.25%, your monthly payments would be $1,104 a month. If you were to get a 5-year ARM at 3.99%, your monthly payments would be $953 for the first five years, for a 5-year savings of $9,060. Add in closing costs, at roughly $2,000, and you will still pay approximately $7,000 less of your hard-earned money during the fixed-rate period.
4. ARMs do not always adjust up. Most people assume that after the fixed period expires, their rate will rise. This is not always the case. You could start with a 5-year ARM at 4.25% and when it becomes time for the rate to adjust, market prices may be considerably lower. This can prove to be quite a bit of savings for you to pay towards the principal of your home, or use the money to pay off debt. On top of that, when the rate does adjust, your payment is based on the current principle balance of your loan. In a 30 year fixed your payment is the same for the entire 30 years, whereas the ARM payment adjusts with principle balance.
5. Adjustable Rate Mortgages are more popular than you think. In the United States, many financially savvy people choose an ARM, mainly because you can save money during the initial fixed-rate period. In fact, in countries like England, variations of ARMs are the only type of mortgage available. This is often due to the fact that you can pay more towards the principal of the loan, early and without penalty. Early reduction payments reduce the total cost of the loan and allow you to pay off your loan in less time.
The thing to keep in mind with the current housing market is that interest rates are on the rise. Rates have been trending higher all month because of good economic reports. The markets reacted to mixed signals from the Federal Reserve that raised the possibility it might begin to slowly taper the purchased of mortgage backed securities. Those purchases have helped keep the interest rates so low.
By the end of this year we could see rates higher but not by a lot. Rates could hover anywhere between 4.25 and 4.75 percent on a 30 year fixed mortgage which is up from the current par pricing of 3.75 percent. We could see refi’s drop to half or slightly more than that of all mortgage applications by the end of the year.
Even though refinance application are down nationally, we are beginning to see that loan customers are considering different loan products, namely adjustable rate mortgages because they offer such low rates for periods of up to 7 years on a VA Hybrid.
Consider the following: Most 30 year mortgages are only on the lenders books for a period of 5 to 7 years before the consumer refinances again. With VA Hybrid rates at or below 3.5% they are a great option for anyone looking to lock in savings.
Remember, while Adjustable Rate Mortgages may save you money over the fixed-rate period, they may not be for everyone. Make sure you talk to your mortgage lender to determine if an ARM is for you; make sure you know all of the facts before signing. Does your lender have prepayment penalties? Make sure you are aware that while rates can go down, this means they also can rise as well. If you are aware of the risks, and have a firm understanding of how an ARM works, then it can prove to be a very positive experience for you.