5 Year ARM – A Hot Alternative!

As we all endure this week’s wintery weathery mix, it seems appropriate to mention a sizzling hot mortgage alternative.  Fixed mortgage rates have pushed up over the last few months creating an unusually large gap between the 30 year fixed rate and the 5 Year Adjustable Rate Mortgage (ARM) rate.

A 5 Year ARM is a unique hybrid program which combines the best features of both the adjustable and fixed rate products.  It delivers a very low interest rate and, therefore, a lower monthly payment typical of ARM’s.  However, it also gives home buyers the stability and predictability of fixed payments that will not increase in the near future as the rate is fixed for the first five years and then can change annually.

As the 30 year fixed rate has surged from 4% to 4.75% over the last few months, the 5 year ARM rate has stayed remarkably low creating an unusually large gap and one heck of an opportunity for certain home buyers.  Contrast this week’s Conforming 30 year fixed rate of 4.75% with only a 3.625% Conforming 5 Year ARM rate.  This 1.125% savings amounts to a monthly payment savings of $131.19 on a $200,000 loan!

We are excited to offer 5 Year ARM’s on both FHA and Jumbo products as well and the savings are equally impressive!  On a $175,000 FHA loan, the 5 Year ARM generates a savings of $102 per month!  On a $500,000 Jumbo loan, the 5 Year ARM generates a savings of $379 per month! 

In addition, the borrower is able to qualify for the loan at the lower note rate and payment!  This can be instrumental in getting a tight loan through!

With the potential of the rate varying after five years, the 5 Year ARM product does have interest rate risk.  However, there are limits on how much the rate can increase each year and an overall cap which limits the most the rate can ever increase.  The annual cap is 1% for the FHA product and 2% for the Conforming/Jumbo option.  After five years the rate is determined each year by adding a margin of 2.25% to the One Year LIBOR Index.  The most the rate can ever increase is 5% over the initial rate.

Although not for everybody, for the right borrower a 5 Year ARM can be a prudent choice.  For anyone planning to move over the next five years, the 5 Year ARM would be the way to go and lead to significant savings.  In our Conforming example above, the $131 monthly savings adds up to $7871 over five years!  Obviously, the rate never even has an opportunity to adjust if the home is sold within five years.  Another good time to use the 5 Year ARM is for a buyer anticipating a salary increase.  This buyer can enjoy the low payment for the first five years and then be able to afford the larger payment later.  It is also a good alternative for someone looking to pay their loan balance down significantly over the first five years because after the fifth year, the loan is recast each year based on the new interest rate and loan balance.  Thus, if the balance has been paid down significantly, the new mortgage payment will also be significantly lower (even if the rate has risen).  Finally, as already mentioned, the 5 Year ARM can be an excellent tool to help reduce a buyer’s debt ratio and enable them to qualify for a larger loan amount and sales price.  There are certainly some good examples of where the 5 Year ARM has saved the day!

With such a wide rate gap, the 5 Year ARM simply can’t be ignored in the present market.  The time has come to understand how it works and to consider it at the appropriate time!

January 11, 2011 by · Leave a Comment

About James

James A. Williamson is currently the Sr VP of Sales Development for Shelter Lending Services (formerly Fairfield Mortgage). James joined Shelter in 1994 and was the company's top Loan Officer in GA for 20 straight years helping over 2500 families finance their homes. James now oversees an incredible group of Loan Officers in Atlanta while further building Shelter's Atlanta business.

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