The following is a guest post from Matt Stoffer, Vice President of the Quicken Loans Scottsdale Web Center.
What do you typically think about when you hear the words adjustable rate mortgage, or ARM? Perhaps, “risky” comes to mind? That perception is easy to understand given news stories that have illustrated them as such over the last several years.
While some ARMs in the past were designed with negative amortization, today’s ARM is fixed for a period of time, adjusts based on market conditions and comes with reasonable maximum caps of how much you could pay.
An ARM can make great financial sense for certain homeowners, and serve as an effective tool in helping you achieve your personal finance goals. But it’s important to understand the how and the why.
First, let’s go over what an ARM really is. The interest rate on an ARM is fixed for a period of five or seven years. After the fixed-rate period, your interest rate can adjust up or down depending on current market conditions. But you don’t have to worry about your rate spiraling out of control, thanks to caps that are in place.
Rate adjustments are capped at 5% above your initial rate and 2% or 5% per adjustment period. For example, if your initial interest rate is 3.625%, your adjusted rate cannot exceed more than 2% or 5% per year, with a maximum of 5% total. So the most your interest rate can ever be on this loan is 8.625%.
Second, let’s review some key points. Interest rates are typically lower than fixed-rate mortgages, which means you’ll enjoy a lower monthly payment during the fixed period. You can refinance up to 95% of your primary home’s value or buy your primary home with as little as 5% down. FHA ARMs are available for those who want more flexible guidelines and the security of a government-backed loan, and VA ARMs are offered as an alternative to fixed rates for qualified military members and their families.
Third, let’s talk about situations where a client could benefit from an ARM:
- You consider your house a starter home or plan on moving before you reach the time your loan will adjust.
- You are disciplined and plan to use the savings during the fixed-rate period to accomplish other goals.
- You relocate every few years because of your job, and enjoy lower monthly payments because you have no use for a long-term loan.
- You plan on retiring and making extra payments to pay the loan down faster, while doing so at the ARM’s lower interest rate.
Next, let’s see some numbers to illustrate why ARMs make sense in the above situations:
Just a few years ago, many homeowners were interested in refinancing to a fixed-rate mortgage to provide the security of a long-term fixed rate. The reality is, many Americans either move or refinance every 5-7 years. If you fall into that bucket, why would you choose a 30-year fixed rate, which is higher than an ARM, for the sake of long-term rate protection that you’ll never utilize?
I personally have an adjustable rate mortgage and have talked about it as a savvy financial tool on a previous Watch-It Wednesday, here on ZING. Many of my friends and coworkers have them too, as you’ll see in this video from Quicken Loans President Jay Farner.
Today, more folks are realizing the benefits of an ARM and the appropriate times when it makes sense to apply for one. Everyone’s situation is unique and your home loan expert can help guide you to the right decision based on your specific goals.