ARM’s – Are They Still Worth Talking About?

With mortgage interest rates at an all-time low, most borrowers are flocking to fixed-rate loans.  About 95% of borrowers over the first half of 2011 have chosen a fixed-rate loan.  And, with rates this low, why wouldn’t they?  There is stability and security in knowing the monthly payment will never change.

So what about adjustable rate mortgages (ARM’s)?  I am not talking here about the true 1 Year ARM where the rate changes every year, but a more conservative 5 or 7 year ARM where the rate is fixed for 5 or 7 years before the rate can change.  Are these still valid options that should be considered?  Would someone be crazy to even consider one?

In some recent markets, the answer would rightfully have been “yes, they would be crazy” and the main reason was that the rate was not low enough to justify the risk associated with the rate being able to adjust at some point.  But, in the current market, the answer is an emphatic “no, they would not be crazy” because the spread between fixed and ARM rates is so great.  Check out the rates below and notice that the rate is approximately 1% lower for a 5 year ARM than a 30 year fixed-rate.  On a $250,000 loan, this is a savings of approximately $125 per month!  The truth is that in both up and down housing markets, there’s a place for ARM’s in specific situations. Here are some examples:

  • The borrower expects to move from their home within 5-7 years or less.  The ARM would always be the best choice in this case.
  • The borrower plans to pay down the balance of the mortgage significantly within next 5-7 years.  Even if the rate rises a lot after the fixed-rate period is up, the fact that the borrower has paid down their balance significantly will prevent the payment from going up much, if at all.
  • The borrower’s income is expected to rise substantially in the future and a lower payment over the next 5-7 years will help the borrower’s budget greatly.
  • The borrower is savvy and although he/she can afford a higher payment, the preference is to minimize the payment and to invest the savings in other areas with the expectation that more money will be earned as a result.

For many borrowers, an ARM may be the best mortgage choice they can make.  It may even make the difference in being able to qualify for the home they wish to buy.  So, what is the best way to figure out if an ARM is a good fit?  The answer is by asking a lot of key questions such as:

  • Does the borrower fully understand the jargon and mechanisms of an ARM?  An understanding of the index, margin, and caps is critical.
  • Can they afford both the introductory payment (fixed for 5 or 7 years) and the higher payment if rate was maxed out? 
  • Is the borrower comfortable with the associated interest rate risk of an ARM?  This might not be the best choice for a worrier.

Keeping an open-mind to an ARM and understanding the value and benefits of considering this option is a wise thing to do because, in the end, an ARM just may be the best loan option for you or your customer!

October 25, 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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