What You Don’t Know About Adjustable Rate Mortgages May Cost You

Tim Renshaw
Published on September 12, 2017

What You Don’t Know About Adjustable Rate Mortgages May Cost You

When shopping for a mortgage, have you noticed how much lower the rates are for a variable mortgage than a fixed?

For example, as of this writing, the average 30-year fixed-mortgage rate is 3.69 percent, while the average rate for a 5/1 adjustable rate mortgage, or ARM, is 3.09 percent, according to BankRate.com.

Despite this, many borrowers shy away from ARMs, based on the horror stories they read in the media or hear from friends and family.

Frankly, I always warn folks away from ARMs. I know significantly more people who got big surprises out of the ARMs than were able to take advantage of them. If you are already a daily follower of the entire economic situation, then ARMs may be your thing. If you think rates between now and when you pay off your AMR will fall (currently highly unlikely), then an ARM might work for you. If not, don’t mess with ARMs.

Here are some things to consider about the adjustable rate mortgage that you ought to know about.

What Is An Adjustable Rate Mortgage?

The ARM is a mortgage loan program with a fixed rate for a pre-determined amount of time. After that, the rate may vary, either up or down, depending on which major mortgage index it is tied to (MTA, COFI or LIBOR).

A popular ARM is the 5/1, where the 5 means that the loan carries a fixed rate for the first five years and the 1 is the number of annual adjustments you may expect.

The second number, by the way, doesn’t always indicate this. “ … there is no set formula defining what the second number indicates,” cautions the staff at Investopedia.com.

ARMs Can be Scary, Even If You Understand Them

The Great Recession: that was one rough period we went through from December 2007 to June 2009. In fact, it’s considered our economy’s “largest downturn since the Great Depression,” according to the experts at Investopedia.com.

The housing crisis hit Americans hard, zapping their home equity. Those who bought their homes with little- or no-documentation “liar loans,” with ARM products, were particularly hard-hit.

Since the government incented and in some cases demanded that lenders disregard whether or not the borrower had the ability to repay the loan, and handed them out like candy, millions of homeowners found themselves with a mortgage payment that skyrocketed just as they were laid off from their jobs.

Unemployment checks can be stretched only so far – so, naturally, with falling home values, when the adjustable period on their mortgages kicked in, many homeowners bailed, walking away from their homes.

Today, proof of the ability to repay a loan is the new norm in the mortgage industry.

But the ARM’s nasty reputation remains. Given the current level of rates, the reputation is deserved.

Going With an ARM in a Period of Historically Low Rates is Not the Best Idea!

It’s probably not a good move to go with an ARM when mortgage rates are low, according to Matthew Frankel at MotleyFool.com.

“Simply put,” he says, “with interest rates still just above record lows, the probability that rates will be lower once the initial teaser rate expires is not good.”

At current low rates, “30-year fixed-rate mortgages are cheap enough that it’s simply not worth taking the risk of a big increase in the mortgage payment a few years down the road,” he concludes.

You can play around with rate scenarios using this online fixed vs. adjustable rate mortgage calculator. Click the “View Report” button on the settings that load by default. Note how much more the ARM costs over the period of 30 years! This “scenario” uses a high interest mark of 11.25%. If you think that is outrageous, play with the settings and see what would need to stay constant for an ARM to come out ahead. Hint: For the ARM to pay off, rates will have to average less than the current low rates available for 30 years! How good is your forecasting ability?

Who Should Consider An Adjustable Rate Mortgage

In my humble, but accurate opinion, given the current low fixed rates available, there is no reason for anyone other than pure gamblers to get an ARM.

What You Don’t Know About Adjustable Rate Mortgages May Cost You
Please use a valid email.
Please fill in all fields.
view now